LIABILITY OF A HOLDING COMPANY FOR THE DEBTS OF ITS INSOLVENT SUBSIDIARY
By
Johanna Barbara Cilliers BA LLB H Dip Co Law LLM
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 my family, especially my 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 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 3 PIERCING THE CORPORATE VEIL
3.1 Background 60
3.2 Fraud 61
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 Nominee directors: notion of 'dual loyalty' 112
4.3.1 Traditional approach 113
4.3.2 Pragmatic approach 114
4.3.3 Notion of 'dual loyalty' similar to Charterbridge test 118
4.4 Duty of care, skill and diligence 121
4.4.1 Scope of duty 121
4.4.2 Statutory formulation of duty 126
4.4.3 Overlap with fiduciary duty 130
4.4.4 Overlap with insolvent trading provisions 133
4.5 Evaluation of position of group creditors 134
4.5.1 Fiduciary duty to act in interests of company 134
4.5.2 Nominee directors 136
4.5.3 Duty of care, skill and diligence 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 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 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, culminatingfin 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 lawfit uneasil y with the modern commercial realities of group enterprise.'3
Consider the following scenario. Company A is the holding company of the ABC 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. When 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 ABC 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
thefinancial assistanc e 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 DK Avgitides, Groups of Companies - The Liability of the Parent Company for the Debts of its Subsidiary, (1996), 43. 7 [1897] AC 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 reformsfive decades earlier, culminating in the Companies Act 1844 (UK). 8 But see, eg, s 588V of the Corporations Act. 9 [1897] AC 22. 10 Ibid 5\. uIbid. 12 HG Henn and JR Alexander, Laws of Corporations and Other Business Enterprises (1983), 19. 13 [1897] AC 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 by 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 may 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 CLR 1; Industrial Equity Ltd v Blackburn (1977) 137 CLR 567. This thesis applies to both formal and informal groups. An 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 PW 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 US 349 (1944), 361 (Douglas J). 24 On the history of limited liability in the United States, see EM Dodd, 'The evolution of limited liability in American industry: Massachusetts' (1948) 61 Harv LRev 1351. 25 [1921] 3 KB 492. 26 Ibid 500 (Lord Sterndale MR). 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 WW Cook, 'Watered stock - Commissions - Blue sky laws - Stock without par value' (1921) 19 Mich L Rev 583. Cf however, WP Hackney and TG Benson, 'Shareholder liability for inadequate capital' (1982) 43 Uof Pitt L Rev 837 at 841 and SM 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 my words when I say that in my 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 NM Butler, 'Why should we change our form of Government', quoted in JC Bonbright and GC 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 New 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. When 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 who invested in the company originally and enjoyed limited liability are now not even liable for their original investment. Liability is therefore being limited twice (or many times) over.
An 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 HA 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 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. When 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 on 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 CM 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] AC 22. Illustrations of catastrophes involving large multinational corporate groups are the Bhopal disaster in India, the Amoco 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 CCH, Collapse Incorporated - Tales, Safeguards & Responsibilities of Corporate Australia (2001). See also F Varess, 'The buck will stop at the board? An 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; RE Meiners, JS Mofsky and RD 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 now 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. RA 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 truefinancial 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 therisk 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. He 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. He 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 misappropriationrisk, 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 may 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. He 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 may prevent the proper re-allocation of risks. The costs involved for creditors in obtaining sufficient information about their credit risk may 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 may 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 CW 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 DW Leebron, 'Limited liability, tort victims, and creditors' (1991) 91 Columb L Rev 1565 and RA 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. JC 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 ACSR 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. 63 DD Prentice, 'Groups of companies: the English experience' in KJ Hopt (ed) Groups of Companies in European Law - Legal and Economic Analyses on Multinational Enterprises 13 group companies may 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 may therefore be justified where the transaction costs are prohibitive, so as to preclude them from protecting themselves by contract against actions that may 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 ofrisk ar e 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 may 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 offiduciary dut y 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 may 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 may 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 who 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 New Zealand, for example, the courts have a wide discretion to deal with group companies in liquidation. The New 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 New 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 givingrise t o the debt. An 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 CASAC paid particular attention to the position in New Zealand and the United States, recommending, inter alia, that the New 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 CASAC Discussion Paper on Corporate Groups (December 1998) and the CASAC Corporate Groups Draft Proposals (October 1999). On 11 March 2002 CASAC became known as the Corporations and Markets Advisory Committee (CAM AC) 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. When 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 When 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 & DR 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 RN 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 GP Stapledon, Corporate Groups in Australia (1998). 95 On 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; RB 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 may 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 may 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, may 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: CSR 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, MA 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 may 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. As 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. CASAC 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 DB 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 thesefive options , see CASAC 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, BC Hunt, The Development of the Business Corporation in England, J800-1867, (1936). For a different, morally grounded, perspective of Salomon v Salomon see, eg, GR 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 CASAC recommendations relating to contribution and pooling are dealt with in Chapter 9, before an exposition of my 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 may 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 CM Schmitthoff, 'Introduction' in CM 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 UK, New 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, TL 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 Ch 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 AA 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. By 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 own economic interests within the controlled company and at the expense of the controlled company.11 In other words, because the controlled company may 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. When 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, may be jeopardised to a serious extent. It is therefore imperative that we look more closely at what is meant by control in this context. As will be 10 An 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. We 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 thefirst bod y 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 may 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 Two 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 (thefirst 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: An 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) thefirst 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 ofs46ofthe 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 On the holding of more than half the issued share capital, see, eg, NCSC v Brierley Investments Ltd (1988) 14 ACLR 177 at 184. 24 (1994) 12 ACSR 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. An 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 may 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 may 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 whom 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 may 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 maximum 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) thefirst-mentioned corporatio n 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 thefirst tes t 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 51% 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 theirright 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'. By reason of the alternative of present ability the 'voting control' test may 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 may be the case where the putative holding company is actually in a position (or has the power) to vote more than 50% 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 ACSR 271 at 281 pointed out that White J in Mount Edon (1994) 12 ACSR 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 ACSR 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 ACSR 271, however, Santow J dealt with this issue expressly. 41 Bluebird Investments (1994) 13 ACSR 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 50% of the votes. Thus, such an underlying arrangement, though not legally enforceable, may 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 50% 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 50% of the votes at a general meeting would be sufficient to create 'a position to cast' more than 50% of the total votes capable of being cast at a general meeting.46 On 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 ACSR 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 own 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 CLR 567- RP 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 thefinancial an d 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 may 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 AASB 1024 (para 9) and AASB 1017 (para 9). 53 Pt 3.6, Div 4A 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 HAJ Ford, RP Austin and IM Ramsay, Ford's Principles of Corporations Law, loose-leaf para 10.201 for a discussion of the history of consolidation. 54 ASC 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. The Deeds o f Cross Guarantee pursuant to the ASIC Class Order and the serious prejudice to creditors (as well as directors) that may 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 who 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'sfinancial and operating policies. (2) In determining whether thefirst entit y has this capacity: (a) the practical influence thefirst 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'sfinancial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust). (3) The 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'sfinancial and operating policies. (4) If thefirst entity : (a) has the capacity to influence decisions about the second entity'sfinancial and operating policies; and (b) is under a legal obligation to exercise that capacity for the benefit of someone other than thefirst entity' s members; th^first entit y 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 50AA 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 50AA may include de facto forms of control that would not fall within the ambit of the holding company/subsidiary and related company tests: CASAC 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 asp rotecting t he resources of a public company, 'in particular, those available to pay the company's creditors', this is no longer the case.63 The object of 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 givingfinancial 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 may be compared with the position of creditors under the maintenance of share capital provisions, where creditors enjoy specific protection.65 Furthermore, the giving of afinancial 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 may thus be given to a wholly owned subsidiary despite the fact that in that particular case the transaction may 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 benefit s 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), No 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, thefirst company, could legally hold shares in a second company, where the first company in reality controlled the second company, as long as thefirst compan y 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 Law 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 50AA 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 Law 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. 76 This would be much easier to prove in the case of a wholly-owned subsidiary. 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 50AA 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' may 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 AASB 1024 and AASB 1017 in para 2.2.2 above. 78 This is different from the previous position where, say, a shareholder with a shareholding of 50% 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 thefinancial policies . 79 The sentiment that joint control does not give either party control is reflected in AASB 1024 and old cases on control such as Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152. 80 Section 50AA(3) of the Corporations Act. 81 (1994) 12 ACSR 727. 82 (1994) 13 ACSR 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 may constitute evidence of control. Moreover, the fact that minority shareholders do not effectively participate in the control of a widely held public company may 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 may control another without the latter being a 'subsidiary' as defined in s 46 of the Corporations 84 (1994) 12 ACSR 727 at 735. 85 (1994) 13 ACSR 27 lat 283. 86 See s 259E (2)(b) of the Corporations Act. 7 R Pennington, 'Personal and real security for group lending' in RM 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 50% of the voting shares of the subsidiary company. De facto control is possible where the holding company holds substantially less than 50% 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 20% 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 20% 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 AMP 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, CASAC suggested that the definition of 'control' as used in s 91 AA 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 50AA of the Corporations Act should be used instead of the current definitions of 'holding/subsidiary' companies.94 CASAC 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 CASAC 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 CASAC 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 On this model, consolidated g roups w ould b e r egulated b y s ingle e nterprise principles. 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. CASAC 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. CASAC 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, CASAC 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. CASAC 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. CASAC 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 CASAC 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 CASAC 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, CASAC stated that imposing collective tort liability on all group companies may serve as a total disincentive to adopting the consolidated group structure: CASAC 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 how to account adequately for the sold company in the event of the consolidated group not keeping separate accounting and other records of that company: CASAC 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 de consolidation: CASAC Final Report, above n 61, para 1.107. See further Ch 8 para 8.2 on Deeds of Cross Guarantee. 49 2.3.2 Critique of CASAC 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 may 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 may be raised. First, it is submitted that CASAC has gone too far by stating that the definition of 'control' contained in s 50AA 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, CASAC suggested that the definition of 'holding/subsidiary' be discarded and replaced with the definition of 'control' in set out in s 50AA 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 50AA of the Corporations Act and suggested by CASAC 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 BG Pettet (ed) Company Law in Change - Current Legal Problems (1987) is in favour of the concept of control but broadening its definition. 113 Cf CASAC 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 By contrast, the concept of control employed by s 50AA 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 50AA 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 50AA 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 CASAC recommendation, it is therefore submitted that the control test should 14 See also the submissions favouring holding company/subsidiary and related company tests in CASAC 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 CASAC 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. As 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 CASAC Final Report, above n 61, para 1.40. According to fh 46 at 15 of the CASAC 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: CASAC 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 ACSR 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 now 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 may 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 thefirst body; or (b) thefirst 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 50AA 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 ACSR 727 and Bluebird Investments (1994) 13 ACSR 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 50AA of the Corporations Act as recommended by CASAC 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 50AA of the Corporations Act and as far as possible objectively ascertainable. It is submitted that this may 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 why 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 On the facts in Mount Edon (1994) 12 ACSR 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'sfinancial an d 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 50AA 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 50AA of the Corporations Act is very similar, as pointed out above. By way of analogy, therefore, no control will exist for purposes of s 50AA 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 50AA 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 new 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 (thefirst 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 thefirst body; (Hi) holds a majority of the capital in thefirst body; or (iv) otherwise holds a strategic position within the decision making organisation of thefirst body that gives the second body the power to influence the business affairs of thefirst 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 holdsfinancial, 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 50AA 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 may also be criticised. The criticism may be summarised by some submissions received by CASAC 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 may 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 may 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 CASAC 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, CASAC 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, CASAC 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. CASAC 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, CASAC concedes that it may 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). CASAC 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, CASAC is of the view that, without thisright, wholly-owned corporate groups might be reluctant to become consolidated. This would mean that, regardless of any change in the overallfinancial circumstance s or internal functions of the group, they would be irrevocably governed by single enterprise principles. Should they retain theright o f 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 CASAC 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 own 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 UK (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 UK). 2 For a summary of the situation in which the courts have lifted the corporate veil, see HAJ Ford, RP Austin and IM Ramsay, Ford's Principles of Corporations Law (2001), paras 4.350- 4.420. 3 For a doctrinal and economic analysis of veil piercing, see SM 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 CLR 1. 7 (1977) 137 CLR 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 lessfrequently i n 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] FCA 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 ER 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 Mr Home as its managing director under a contract containing a post-contract non-solicitation clause. When his contract expired Mr Home set up a company to carry on a competing business. In the English Court of Appeal, Lord Hanworth MR said that the company was a cloak or sham, a mere device for enabling Mr Home to breach his contract. Accordingly, the court issued an 1 "7 injunction against both Mr Home and the company. The second case is Jones v Lipman}* which followed the decision in Gilford}9 In this case Mr Lipman sold his house to Mr Jones. Mr Lipman subsequently attempted to avoid being compelled to convey the property to Mr Jones by incorporating a limited liability company and conveying the property to the company. Russell J ordered specific p erformance against both Mr 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 WLR 832 (Jones). 19 [1933] All ER 109. 63 an American subsidiary, North American Asbestos Corp (NAAC). In the beginning of the seventies employees of a subsidiary of NAAC, who contracted asbestosis, instituted action against certain companies in the Cape group, including NAAC itself, Cape and Capasco. This resulted in a settlement. NAAC was dissolved in 1978 but Continental Productions Corp (CPC), incorporated in 1977, continued its activities. Although CPC was not a subsidiary of Cape, it was incorporated with the financial assistance of the latter. After NAAC'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 NAAC. Furthermore, they were of the opinion that, since the dissolution of NAAC, Cape and Capasco were involved with the American asbestos industry via CPC. Although CPC was not a subsidiary of Cape, it acted on the instructions of Associated Mineral Corp (AMC), a wholly owned subsidiary of Cape that had been incorporated in Lichtenstein. The plaintiffs argued that the interposition of AMC between Cape and CPC served as proof of Cape's involvement in the American market since Cape could continue reaping profits of the asbestos industry without furtherrisks o f 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 AAC and CPC 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 offraud. It deals in detail with the allegation of the plaintiffs that the formation and use of CPC and AMC 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, AMC 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 may 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 bed 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 WLR 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 AMC there was clearly a facade, but that it would not be of any assistance for the plaintiffs because AMC 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 AMC. The Court of Appeal found that the crucial factor was the relationship between Cape/Capasco and CPC, because CPC 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 'suchrights 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 offraud in very exceptional cases. This could not be established Ibid 1025. It was found by Scott J atfirst instance that AMC was 'no more than a corporate name' (at 967) and that AMC was a 'creature of Cape' (at 969). This was confirmed on appeal (at 1025). 30 Ibid 1025. 31 [1962] 1 WLR 832. ML 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 Mr 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. When Welwyn summarily dismissed Mr 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 Mr 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 Mr Creasey for damages to be assessed. When Welwyn was subsequently struck off the register and dissolved, Mr 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. On appeal Mr Richard Southwell QC, 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 Mr 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 ER 929. 37 [1993] BCLC 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] BCLC 480 at 492. 67 for the remaining liability of Welwyn.39 Richard Southwell QC 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] BCLC 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] BCLC 480. 43 [1997] 2 Lloyd's Rep 465. " Ibid 414. 45 [1993] BCLC 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 ER 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 ER 109, Jones [1962] 1 WLR 832, Creasey [1993] BCLC 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 ER 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 Mr 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. Mr and Mrs Ord thereupon requested the court 47 [1993] BCLC 480. 48 [1997] 2 Lloyd's Rep 465. 49 [1998] 2 BCLC 447 (Ord). 50 [1991] 1 All ER 929. 51 [1998] 2 BCLC 447. 52 [1993] BCLC 480. 53 [1998] 2 BCLC 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) Was 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) Was the holding company the head and brain behind the business? (d) Did the holding company control the business? (e) Was 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] AC 22) or a wholly-owned subsidiary (see, eg, Adams v Cape [1991] 1 All ER 929) is, however, insufficient. 57 [1939] 4 All ER 116 (Smith, Stone and Knight). 68 Ibid 121. 69 [1969] 1 NSWR 676 (Hotel Terrigal). Cf Dennis Wilcox Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 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. An example of such a circumstance would be where a subsidiary without its own separatefinance an d 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 90% 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 thefilm. Th e 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 WLR 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' CPC and NAAC. The English Court of Appeal found on the facts that a very substantial part of the business carried on by NAAC 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 NAAC had no general authority to bind Cape/Capasco to any contracts and the fact that NAAC83 never concluded any transaction in a way that bound Cape/Capasco contractually. The English Court of Appeal concluded that the activities of NAAC were its own activities exclusively, and not those of Cape/Capasco. NAAC 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 CPC was 8 [1897] AC 22. 9 CM Schmitthoff, 'Salomon in the shadow' (1976) JBL 305 at 309 and 311. 0 CM 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 NAAC, CPC 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. On 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 NAAC and CPC 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 WLR 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 WLR 483, [1953] 1 All ER 615. 95 [1991] 1 All ER 929. 96 Davies, above n 14, 173. 97 Lennarts, above n 32, 161. 98 [1991] 1 All ER 929. 99 Lennarts, above n 32,161. 100 See RC Schulte, Groups of Companies: The Parent-Subsidiary Relationship and Creditors' Remedies (1999), 65. 101 [1969] 3 All ER 855 at 860. See also McKenzie v Gianoutos & Booleris [1957] NZLR 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. DHN 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 DHN 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, DHN was treated before the Land Tribunal as a periodic yearly tenant of Bronze. As a result DHN 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 DHN 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. On 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 DHN 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 NZLR 136; Bentley Poultry Farm Ltd v Canterbury Poultry Farmers Association (1989) 4 NZCLC 64,780. " [1976] 3 All ER 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, DHN, should be treated as that one. So DHN are entitled to claim compensation accordingly.''' 105 Ibid. 106 [1976] 3 All ER 462. 107 See Sugarman and Webb, above n 103, 174. 108 DHNv Tower Hamlets [1976] 3 All ER 462 at 860. 109 LCB Gower, Gower's Principles of Modern Company Law (1969), 216. 110 DHN v Tower Hamlets [1976] 3 All ER 462 at 467. 111 Harold Holdsworth & Co (Wakefield) Ltd v Caddies [ 1955] 1 All ER 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. Mr 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, FG 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 New Zealand case of Official Assignee v 15 Insell Avenue [2001] 2 NZLR 492, Paterson J pointed out (at 502) that the New Zealand Court of Appeal in Savill v Chase Holdings (Wellington) Ltd [1989] 1 NZLR 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 NZCLC 261,086. I151978SC(HL)90. 1I6[1976]3A11ER462. ,I71978SC(HL)90. 118 [1976] 3 All ER 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 MR 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 BP 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 BP 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 man 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)'.x25 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 me 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. As an altemative s olution the holding c ompany c ould ensure that the articles of association of the subsidiary were amended to give shareholders aright t o 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 New 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 ER 855. 127 [1976] 3 All ER 462. 128 [1980] lQB358at373. 129 (1986) 5 NSWLR 254 (Yelnah). See further Bluecorp Pty Ltd (in liq) v ANZ Executors and Trustee Co Ltd (1995) 18 ACSR 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 WAR 440 at 451. See also Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549 at 577. 80 Hargreaves, Ward and Armstrong and which was known as the Hi-Quality Group. Hi-Quality Concrete (NSW) 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 (NSW) 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] AC 22 is unknown. In that world human realities, not corporate formalities, reign.'133 130 Yelnah (1986) 5 NSWLR 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. 1351978SC(HL)90. Two 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 ER Rep 109). 137 Yelnah (1986) 5 NSWLR 254 at 267. 138 DHN v Tower Hamlets [1976] 3 All ER 462 was also distinguished in subsequent Australian cases. See, eg, Dennis Wilcox Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 267 at 274 (Jenkinson J) and State Bank of Victoria v Parry (1990) 2 ACSR 15 at 32 139 [1983] 3 WLR 492 (Multinational Gas). wIbid. 82 only shareholders in Multinational Gas and Petrochemical Co (MGP), incorporated in Liberia. MGP carried on the business of dealing in liquefied gas products.141 For fiscal reasons a separate management company, Multinational Gas and Petroleum Services Ltd (MGP Services), was incorporated in the United Kingdom to provide advice to MGP and carry out management functions. Employees of the three oil companies were appointed as directors of MGP from time to time. Again forfiscal reason s the directors' meetings of MGP were held outside England on all relevant occasions. The directors of MGP took a highly speculative decision to purchase oil tankers for lease. The decision had disastrous results. Both MGP and MGP 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 MGP. He instituted action against MGP 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 MGP 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. Two grounds were alleged on which the jurisdiction of the English court could be based. Thefirst 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 thefirst groun d of authority the English Court of Appeal considered that the alleged tort by the directors of MGP 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 WLR 492. 1491978SC(HL)90. 150 [1983] 3 WLR 492. 151 See Rixon, above n 112, 422; Wilkinson, above n 44, 126. 152 [1983] 3 WLR 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 New 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 QAFL held by Schroders on its behalf. QALF alleged that the loss was that 154 [1976] 3 All ER 462. '"[1991] 1 All ER 929. 156 Ibid. 157 Adams v Cape [1991] 1 All ER 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 ER 929 atl019. It should be noted here that the English Court of Appeal qualified DHN v Tower Hamlets [1976] 3 All ER 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 whom 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 ER 929. 160 (1991) 9 ACLC 109 (Qintex v Schroders). 161 Ibid 110. 162 Ibid III. 163 Qintex v Schroders (1991) 9 ACLC 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 ACLC 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 AG (Marc Rich), a Swiss company. Avalon was incorporated in Gibraltar for tax reasons. Avalon bought a damaged ship, the Coral Rose, for almost US$ 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 SA (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') tofreeze asset s 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 US$ 3 million to a frozen account. Avalon subsequently sold the ship to a third party for US$ 10,7 million. US$ 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 ER 769 (Atlas Maritime). See also TSB Private Bank International SA v Chabra [1992] 1 WLR 231. 166 Atlas Maritime [1991] 4 All ER 769 at 772-773. 87 have exhausted the funds covered by the Mareva injunction.168 Atfirst instanc e 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 ER 480 at 487, [1981] QB 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 ER 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 my 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 ER 929 at 1020, [1990] Ch 433 at 537, a holding company isfree t o 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 ER 929 at 1024-1025, [1990] Ch 433 at 542-543. 74 [1991] 1A11ER929. 75 Ibid 1024. 76 Atlas Maritime [1991] 4 All ER 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 my 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 may 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 May 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 ER 769. 189 [1996] 2 All ER 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 QB 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 aright 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] AC 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. Mr 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 notfind any reason to departfrom the principle in Salomon v Salomon [1897] AC 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. On 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 New 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 Mr 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 CLR 1. 207 Wimborne v Brien (1997) 23 ACSR 576 at 581 (Dunford AJA). Ibid. 209 Ibid. 210 (1997) 24 ACSR 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. When the AAT accepted this argument, the Repatriation Commission appealed on the basis that the AAT acted contrary to law in piercing the corporate veil, that the AAT 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 ACSR 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 ACSR 576: see Baxt, 'The corporate veil remains', above n 210, 50-51. 215 [1897] AC 22. 216 Repatriation Commission v Harrison (1997) 24 ACSR 711 at 715. 217 (1989) 16 NSWLR 549. 95 918 fact where one company exercised complete control over another. But, as Baxt points out, Rogers AJA 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 ACSR 711 at 716. See also the decision of the NSW Court of Appeal in James Hardie & Co Pty Limited v Putt Matter, unreported, NSW 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] AC 22. See Repatriation Commission v Harrison (1997) 24 ACSR 711 at 716. 221 Baxt, 'The corporate veil remains', above 210, 50. 12 No 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 ER 462 and Woolfson 1978 SC (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 To 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 NZCLC 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] AC 22. 228 See N James, 'Separate legal personality; legal reality and metaphor' (1993) 5 Bond L Rev 217 at 226. 229 (1991) 9 ACLC 109. 230 (1997) 23 ACSR 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 Nominee directors: notion of 'dual loyalty' 112 4.3.1 Traditional approach 113 4.3.2 Pragmatic approach 114 4.3.3 Notion of 'dual loyalty' similar to Charterbridge test 118 4.4 Duty of care, skill and diligence 121 4.4.1 Scope of duty 121 4.4.2 Statutory formulation of duty 126 4.4.3 Overlap with fiduciary duty 130 4.4.4 Overlap with insolvent trading provisions 133 4.5 Evaluation of position of group creditors 134 4.5.1 Fiduciary duty to act in interests of company 134 4.5.2 Nominee directors 136 4.5.3 Duty of care, skill and diligence 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 ACLC 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; PD 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 MR held that directors 'must exercise their discretion bona fide in what they consider - not what a court may 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 Bowen 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 bonafide 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 ACLC 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 may not exercise their discretion for a collateral or improper purpose. 10 (1883) 23 ChD 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. When 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 may 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 common 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 On 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. He 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 NSWR 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 CLR 146 likewise recognised derivative benefits. 17 (1972) 5 SASR 386 (ReidMurray) at 402. 18 (1976) 137 CLR 1. 19 For detailed discussion of Walker v Wimborne (1976) 137 CLR 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 CLR 1 at 7. See also R Baxt, 'Commercial Law Note' (1976) 50 AU 591-593. Subsequently Kirby P in Parker v NRMA (1993) 11 ACSR 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. On 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 CLR 1. (1977) 137 CLR 567 at 577. This has been reaffirmed on numerous occasions. See, eg, Qintex Australia Finance Ltd v Schroders Australia Ltd (1991) 9 ACLC 109 at 111; Equiticorp v BNZ (1993) 11 ACLC 952 at 984. 25 [1897] AC 22 (Salomon v Salomon). (1976) 137 CLR 1. This decision is a strict application o f the rule in Salomon v Salomon [1897] AC 22. 17 The decision in Walker v Wimborne (1976) 137 CLR 1 is a strict application of the rule in Salomon v Salomon [1897] AC 22. 104 The theoretical objection may 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 nop 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 WLR 202; McPhail v Doulton [1971] AC 424. 105 other companies in the group.30 The beneficiaries of a discretionary trust have theright t o 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. Thefirst 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 afiduciary 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 New 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 man 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. On 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 New 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 atfirst instance found on the facts that there was no breach offiduciary 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 atfirst 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 infinancial 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 CLR 1. 61 Ibid. 68 (1997) 26 ACSR 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 ACLC 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 theirfiduciary duties. 70 (1976) 137 CLR 1. 110 important, as it was thefirst expres s 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 thefiduciary dut y 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 ACSR 544 at 585. It should be noted that Hansen J refers to the fiduciary duty to act for proper purposes as distinct from thefiduciary dut y to act in the best interests of the company. See n 4 above. 73 Farrow (1997) 26 ACSR 544 at 585. 74 (1993) 11 ACLC 952. 75 (1997) 26 ACSR 544 at 580-581. 76 (1976) 137 CLR 1. 77 (1997) 26 ACSR 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 New 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 owe 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 ACSR 465 no reference was made to Farrow (1997) 26 ACSR 544. 92 (1999) 30 ACSR 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 NSW, 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 New 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 ER 66. A strict view was also followed in Breckland Group Holdings Ltd v London & Suffolk Properties Ltd (1988) 4 BCC 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 arale 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 QB 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 leftfree t o 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 New 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 WN (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 EW 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 NZLR 30 (Dairy Containers) at 96. 109 [1962] NSWR 686. 115 company) appointed the nominee directors, the principle laid down 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 who 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 my view to apply the broad principle, governing thefiduciary duty of directors, to a particular situation, where the breadth of thefiduciary dut y has been narrowed, by agreement amongst the body of the shareholders ... It does not follow, in my 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 theirfiduciary 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 NZLR 30 at 96. 111 Levin v Clark [1962] NSWR 686 at 700 and 701. 112 [1964-5] NSWR 1648 (Re Broadcasting Station 2GB). 113 [1962] NSWR 686. 1,4 [1964-5] NSWR 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 offiduciary liability , limited to circumstances where therights o f 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 bonafide 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. On 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] NSWR 686. 119 [1980] 2 NZLR 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 classicfiduciary duty to avoid a conflict of interest or duties' (1994) 22 A Bus L Rev 99 at 103 n53. 121 Berlei Hestia [1980] 2 NZLR 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 New Zealand after Levin v Clark, Re Broadcasting Station 2GBni and Berlei Hestian* as follows:129 On 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 offiduciary obligation. 130 122 Ibid 161. 123 Ibid. 124 Ibid 161 and 165. See further AS Sievers, 'Finding theright balance: the 2GB 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 New Zealand case of Trounce and Wakefield v NCF Kaiapoi Ltd (1985) 2 NZCLC 99,422 and by Beaumont J in the Federal Court of Australia in Molomby v Whitehead and the ABC (1985) 63 ALR 282. [1995] 2 NZLR 30. This case is discussed in more detail in Ch 6 para 6.3. 126 [1962] NSWR 686. 127 [1964-5] NSWR 1648. 128 [1980] 2 NZLR 150. 129 [1995] 2 NZLR 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 CLR 41. The majority of the High Court (Gibbs CJ, Wilson and Dawson JJ) held that HPI did not owe any fiduciary duty to USSC and that, as a result, the relief that USSC 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 USSC on the ground of equitablefraud, hi s Honour found, like the majority, that a fiduciary relationship did not exist between USSC and HPI. Deane J conceded that the conclusion that the overall relationship between USSC 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 own 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 afiduciary 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] NSWR 686. 133 [1964-5] NSWR 1648. 134 Berlei Hestia [1980] 2 NZLR 150 at 165-166. 135 Ibid. 136 [1962] NSWR 686. 137 [1964-5] NSWR 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 who 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 may 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 own 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 CASAC 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] NSWR 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 ACLC 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 may 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] NSWR 686. 147 (1998) 16 ACLC 1172 at 1,177. 148 Ibid 1,196. 149 [1962] NSWR 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 thefiduciary 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 may 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 NSWLR 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 after 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 ACLC 946 (Friedrich). 159 See Vrisakis v ASC (1993) 9 WAR 395. 160 The Companies and Securities Law Review Committee conceded in its Report on Company Directors and Officers: Indemnification, Relief and Insurance, Report No 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 ACLC 933 (A WA v Daniels). 162 (1995) 13 ACLC 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 ALR 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. Atfirst instanc e Rogers CJ found that the auditors were negligent, and that AWA 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 CJ 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 ACLC 946. On 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 'AWA 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 ACLC 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 ACLC 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 New 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 AWA and the auditors. However, on appeal the majority disagreed with the reasoning of Rogers CJ atfirst instance, stating that his view did not accurately reflect the extent of directors' duties in modem 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 WAR 105; Vrisakis v ASC (1993) 9 WAR 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 sellingfruit an d 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 ACLC 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 MJ Trebilcock, 'The Liability of Company Directors for Negligence' (1969) 32 MLR 499 at 510-511; AL 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 BCLC 561 at 563. ^ Daniels v Anderson (1995) 13 ACLC 614 at 667-668. 178 (1997) 24 ACSR 369 (Gamble). This case is discussed in more detail in para 4.4.3 below 179 (1995) 13 ACLC 614. 180 (1997) 24 ACSR 369. 181 Ibid 313. 126 As Ipp J pointed out in Vrisakis v ASC (1993) 9 WAR 395 at 451; 11 ACSR 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 ACLC 614. 183 (1997) 24 ACSR 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' directorfinally bee n 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 ACLC 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 may not be taken into account to lower their statutory duty of care. It may 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 CLERP Draft Paper No 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 CLERP 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 ER 97. On 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 Law 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 may 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 AWA 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 ACLC 614. 195 CLERP Directors' Duties and Corporate Governance: Facilitating Innovation and Protecting Investors, Proposals for Reform: Paper No 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 Memorandum to the CLERP 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. Thefirst conditio n 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. An example would be undertaking a new business activity. On 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 CLERP 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 may 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 NSW, 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 theirfiduciary 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. Mr 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. Mr 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 Mr Hoffmann did not understand the separate entity doctrine. He did not see Tallimba, Sunhaven and himself as separate legal entities. He saw them all as 'one and the same thing'.206 Being under this mistaken belief, Mr 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 ACSR 369. 205 Ibid 376. 206 Ibid 318. 207 Ibid 377. 132 Tallimba.209 There is a striking resemblance between thefirst 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 offiduciary 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 hisfiduciary dut y 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 offiduciary 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 ACSR 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 ACSR 544. 2X2 Ibid 5m. 213 (1997) 26 ACSR 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 may 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. On 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 may be used to guide directors who 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 common 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 may take into account the interests of other companies in the group without breaching their fiduciary 227 duty towards their own 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 thefirst Australian decision after Walker v Wimborne to adopt expressly an objective approach in a group context. The New 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, now 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 thefinancial positio n 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 ACLC 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 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 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 may 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; GD Cooper and DB 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 CLR 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 why 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 may 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 CASAC Corporate Groups Final Report, May 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 CASAC, Final Report, above n 6, 44), a 'lateral' transaction 'involves benefits passing between controlled companies within the same corporate group' (see CASAC, Final Report, above n 6,45). 9 See the discussion of Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 Ch 62 in Ch 4 para 4.2.1. See further Nicholas v Soundcraft Electronics [1993] BCLC 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 dut y 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 may 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 theirfiduciary dut y 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. On 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 infinancial transactions: a policy perspective' (1997) 8 JBFLP 212 at 218-225. 16 (1990) 2 ACSR 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 may 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 (MUA) during thefirst hal f 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 Qd R 360 at 371. An 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 Qd 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 No 2 Pty Ltd, one of the group companies.25 The interest of Patrick Stevedore Operations No 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. When 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 ACSR 521; affirmed by (1998) 27 ACSR 535 (Patrick's case). The decision of North J i n the Federal Court, atfirst instance , is reported as Maritime Union of Australia v Patrick Stevedores No 1 Pty Ltd (1998) 27 ACSR 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 modem 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 MUA 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 CLR 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 MUA 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 employerfirst becam e 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 ACSR 521; affirmed by (1998) 27 ACSR 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. Seefiirther 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 who 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 CLR 1 would probably meet the statutory definition of 'uncommercial transaction', thereby triggering the operation of the insolvent trading provisions. On 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 Ch 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 588Vands 588G of the Corporations Act respectively, namely ss 588W and 588M of the Corporations Act. See further Ch 7 para 7.3.1.2 on the meaning of 'insolvent'. 50 It may 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 wasfiled. Th e 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 wasfiled; 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 whichfinancial statements are made up; and (ii) adjustments to be made in preparing financial statements.' See in this regard Van Reesema v Flavel (1992) 7 ACSR 225, which was followed in Love v ASC (2000) 36 ACSR 363. See also ASIC v ABC Fund Managers Ltd (2001) 39 ACSR 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. On 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 common directors and common shareholders. The liquidator of Rivarolo alleged that there was no evidence that the transferred liabilities were legitimate debts of the company. He 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 ACSR 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 ACSR 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 ACSR 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 may 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 common 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. He 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 ACSR 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 may 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 The c ourt found that the subsidiary was insolvent. The only remaining question for decision was whether the purported forgiveness fell 55 Kitay (1998) 27 ACSR 716 at 720. 66 Parker J in Kitay (1998) 27 ACSR 716 at 720 relied on Walker v Wimborne (1976) 137 CLR 1 at 6. 67 Kitay (1998) 27 ACSR 716 at 720. 68 (2000) 18 ACLC 490 (Lewis). See also Sparks v Berry (2001) 1 9 ACLC 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. He 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 ACLC 490 at 496-497. 72 (1997) 15 ACLC 1,716. 73 Ibid 1,727. Young J in McDonald v Hanselmann (1998) 28 ACSR 49 at 53 also referred to Demondrille Nominees Pty Ltd v Shirlaw (1997) 15 ACLC 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 ACSR 466. In Tosich (1997) 23 ACSR 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 ACLC 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 may 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 owefiduciary 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, New Zealand and the United Kingdom have been prepared to find that, in particular circumstances, directors may be obliged to take into 89 account the interests of creditors to fulfill theirfiduciary duties. The debate " Ibid 499. 78 [1925] Ch 407. 79 Directors also do not owe theirfiduciary dutie s to individual members: Percival v Wright [1902] 2 Ch 421. 80 [1897] AC 22 (Salomon v Salomon). 81 Percival v Wright [1902] 2 Ch421, which wasreliedonby the Report in the UK 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 NZLR 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 dutie s and their duty of care. 83 (1976) 137CLR1 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] AC 22. Like Walker v Wimborne (1976) 137 CLR 1, the ruling by the English Court of Appeal in In Re Horsley & Weight Ltd [1982] 3 WLR 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 CLR 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 CLR 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, DA 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 MR Pasban, 'A review of directors' liabilities of an insolvent company in the US 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 who 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 NZLR 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 NZLR 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 By 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 New 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 thefirst t o 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. On 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 NSWLR 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 offiduciary dut y 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 NSWLR 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 NSWLR 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 afiduciary 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 thefinancially trouble d 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 realrisk o f insolvency'.114 value of its assets. See further SR McDonnell, 'Geyer v Ingersoll Publications Co: Insolvency shifts directors' burdenfrom shareholder s 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] WAR 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 who 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 SASR 410. 116 See J Dabner, 'Directors' duties - the schizoid company' (1988) C&SLJ 105 at 107. See also Re Welfab Engineers Ltd [1990] BCC 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 ER 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 ER 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 ER 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 On 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 orfinancial 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 may 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 (NSW), this sentiment was confirmed. In this case the New 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. When the matter came before the court in High Court of New 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] WAR 183. 132 [1987] 1A11ER114. 133 [1990] WAR 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 No 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 (NSW) erred in using its powers under the Criminal Appeal Act 1912 (NSW) 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 (NSW) should be quashed. Mr Spies (Spies) and Mr 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 NZLR 442 at 475. 141 (2000) 18 ACLC 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 experiencedfinancial 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. As 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 who 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 Now 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 ACLC 727 at 730-1. 146 (1976) 137 CLR 1. 147 Spies v The Queen (2000) 18 ACLC 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 ACLC 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, UK 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 ACLC 727 at 731. 164 majority of the High Court quoted with approval from the judgment of Gummow J in Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler15 0 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 aright b y 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, Gummow and Hayne JJ. Callinan J delivered a separate judgment. 150 (1994) 122 ALR 531 (New World Alliance) at 550. 151 Spies v The Queen (2000) 18 ACLC 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 SASR 410. 153 [1985] 1 NZLR 242. 154 Spies v The Queen (2000) 18 ACLC 727 at 731. This is in line with the recent English case of Yukong Line Ltd v Rendsburg Investments [1998] 2 BCLC 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 ER 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. On 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] VR 434 at 438. 158 See also Ford, Austin and Ramsay, above n 34, para 8.065. 159 (1991) 3 ACSR 207 at 227. 160 (1997) 23 ACSR 355 at 365. 161 (1988) 6 ACLC 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] VR 434. In corporations 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 ACLC 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 CLERP, recognising that directors of a subsidiary may in certain circumstances take into 165 See further HAJ Ford, RP 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] VR 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 courtfinds 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 may 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 CLERP 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 may 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 No 8 (1989) at 3. Section 187 excludes directors'fiduciary dutie s in these circumstances. Since s 187 defines the content of directors'fiduciary dutie s in this context, there can be no breach offiduciary 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 theirfiduciary duty. In New 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 New 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 may 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 ACLC 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 original C LERP Draft Bill was, however, subsequently omitted for further review by the Companies and Securities Advisory Committee (CASAC).179 CASAC 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 2D Pt 2D.1 of the Draft Legislative Provisions of CLERP entitled 'New Directors' duties and corporate governance provisions'. 177 This was previously s 8(2) of the draft CLERP legislation, which was never enacted. ^ January 1998 CLERP Draft Bill, cl 8 of Chapter 2D (p 107 of the draft). For a discussion of the provision on partly-owned subsidiaries, see CASAC Final Report, above n 6, paras 2.36-2.38. 180 CASAC Final Report, above n 6, Recommendation 3. As part of this Recommendation, CASAC 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. By 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 hisfiduciary an d 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. Atfirst 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.]8 5 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 ACSR 737 (Pascoe). XS2 Ibid 164. 183 Pascoe Ltd (in liq) v Lucas (1999) 33 ACSR 357 (Lander J). 184 Pascoe (1998) 27 ACSR 737 at 766. 185 Ibid 769-770. Like the court atfirst instance , the Court of Appeal in Pascoe Ltd (in liq) v Lucas (1999) 33 ACSR 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 CLR 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 why 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 offiduciary 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] WAR 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 CLR 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 now 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 may 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 10% 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 90% 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 may 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 may 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 ACLC 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 ACLR 546; Kinsela (1986) 4 NSWLR 722; Jeffree [1990] WAR 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 may 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 no further than confirming that directors have a fiduciary duty towards their company. In this regard it is submitted that Gummow 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 New 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 ACLC 727. 216 (1994) 122 ALR 531. 1X1 Ibid 55Q. 218 (2000) 18 ACLC 727. 177 more exactly one may 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 may 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 may 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 thefinal 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 New 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 may 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 dutie s is favoured, may 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 may act in what they believe is in the best interests of the holding company. They may 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 New Zealand provision goes further than the Australian one by specifically stating that the nominee director may 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] NSWR 686. 227 [1964-5] NSWR 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 theirfiduciary dut y 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 may ratify a breach of directors' common-law duty to the company,231 doubt exists as to whether they may validly ratify a breach of directors' statutory duty to the company.232 On appeal Lander J held that it was possible for a sole shareholder to authorise a transaction that gaverise t o a breach offiduciary 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 By 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 NSWLR 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 ACSR 357 at 386. 234 This issue was not considered by the Full Court. 235 (1998) 27 ACSR 737. 180 shareholders may 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 When 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 may 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 ACSR 73 at 89, approved by Young J in Gray Eisdell Timms Pty Ltd v Combined Auctions Pty Ltd (1995) 17 ACSR 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 ACSR 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 CASAC 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) ATPR para 40-605 at p 48,334; Collins Marrickville Pty Ltd v Henjo Investments Pty Ltd (1987) ATPR para 40-783 at pp 48,539-48-540; McMahon v Pomeroy Pty Ltd (1991) ATPR 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 CASAC 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, NC Seddon and MP 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 CLR 1. 245 (1998) 27 ACSR 737. 246 A number of other differences exist between the decision in Pascoe and s 187 of the Corporations Act. An 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 GW Hone 'Pascoe's case and the business judgment rule - commentary on paper by Richard England', paper delivered at the Corporations Law Workshop, Business Law Section of the Law Council of Australia, 27-29 August 1999, Fairmont Resort, Leura, NSW 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 may 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 may 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 may be held liable for the debts of its insolvent subsidiary.4 These include the provisions in terms of which a holding company may 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 Ch 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 Ch 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 who 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 may 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. Bye 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 NSWLR 290 (Antico). Further support may be found in Re a Company (No 005009 of 1987); Ex parte Copp [1989] BCLC 13; Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 (Kuwait); Re Hydrodan (Corby) Ltd [1994] BCC 161 (Re Hydrodan) and Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 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 BCLC 324. 0 Re Hydrodan [1994] BCC 161, discussed in more detail in para 6.3 below. "[1994] BCC 161. 12 Ibid 163. Cf Secretary of State v Deverell [2000] 2 BCLC 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 Von 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 thefirst 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, New 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 UK the offence offraudulent tradin g 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 SA (Rumasa), could give assurances of continuedfinancial 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 UK 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) LR 5 ChApp 538. This interpretation is now 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 ALR 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 BCC 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 who 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 tofraudulent tradin g 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 offraudulent inten t 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] BCLC 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 thefraudulent 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 andfraudulent trading' (1986) 7 Co Law 245 at 245- 246; DD 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 BCC 99,075 (Grantham). 31 Ibid 99,078. 32 Unreported judgment delivered on 30 June 1960. 33 Grantham (1984) 1 BCC 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 BCC 99,075 at 99,079. See also RC 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 New 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 thefraudulent 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 BCC 99,075. 36 Hardie v Hanson (1959-1960) 33 ALJR 455; Flavel v Semmens (1987) 5 ACLC 868. 37 Re Day-Nite Carriers Ltd (in liq) [1975] 1 NZLR 172; Re Southmall Hardware Ltd (in liq) (1984) 2 NZCLC 99,102. The provision onfraudulent trading has largely fallen into disuse following the introduction of the wrongful trading provisions in the UK, and the insolvent trading provisions in Australia and New Zealand. 38 D Prentice, 'Insolvency and the group' in RM Goode (ed), Group Trading and the Lending Banker (1988) 75 at 75-8. 39 [1986] BCLC 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; DD 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 may 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 An 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 may 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 common 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 TE 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 BCLC 561. 48 GP Stapledon, "The A WA case: non-executive directors, auditors, and corporate governance issues in court' in DD 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 CLC 5 20 a 15 50. S ee further M R Pasban, 'A review of directors' liabilities of an insolvent company in the US 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 LCB Gower, Gower's Principles of Modern Company Law (1992). 54 Ibid 113. 55 Davies, above n 42, 154. 56 [1986] BCLC 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 (ALRC) 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 DD Prentice, 'Fraudulent trading: parent company's liability for the debts of its subsidiary' (1987) 103 LQR 11; Muscat, above n 29, 214 fh 2; ML 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 ALRC, 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] AC 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 Ch 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 ACLC 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 New Zealand case of Hilton International Ltd v Hilton [1989] NZLR 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 Ch 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 may 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 may 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 ACSR 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 ACSR 589 which is discussed in Ch 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 offiduciary dut y is concerned. 196 circumstances, the director ought fairly to be excused.79 In addition to an order for compensation, a civil penalty order may be obtained against the directors or they may be prosecuted criminally.80 6.2.3 Position in New Zealand New Zealand has similar provisions relating to insolvent trading. The New 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; SM 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] VR 783, R v Harvey [1993] 2 Qd R 389, R v Bonollo [1981] VR 633, R v Love [1989] 17 NSWLR 608 and R v Ghosh [1982] 2 All ER 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 LR 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 substantialrisk o f 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 New 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 NZLR 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 GW 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 may 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 thefirst 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 NZCLC 261,765 a 12 61,778. S ee a lso B enchmark Building S upplies Ltd v Jackson (2001) 9 N ZCLC 262,612; Lawrence v Jacobson (2001) 9 NZCLC 262,477. 88 R Deane, 'Besieged by duties: Will the Companies Act work for directors?' (The Company Law Conference, 1994, NZ Law Society) at 3; J Dabner 'Insolvent trading: Recent developments in Australia, New 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 ofrisk-taking wa s also recognised by the New Zealand Law Commission, Company Law Reform and Restatement, Report No 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 New Zealand equivalent of s 588G of the Corporations Act. 92 Re Petherick Exclusive Fashions Ltd (1987) 3 NZCLC 99,946 at 99,958; Vinyl Processors (New Zealand) Ltd v Cant [1991] 2 NZLR 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 New Zealand for the benefit of a person who 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 NZCLC 67,680, which was decided on the provisions of the Companies Act 1955 (NZ). See further VCS 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 New 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 whom 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 Al 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] BCC 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 UK. The company law legislation in New Zealand and each of the Australian States have also contained a similar provision. 201 profitability subsequently decreased and it started having liquidity problems. When 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 thefinancial standin g 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 own 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 When 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 New 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 New 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). By 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] BCLC 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 i n Australia' (1998) 9 JBFLP 184. 112 [1991] 1 AC 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 BCLC 242. 203 directors. KAB 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 KAB as a defendant in the consolidated proceedings, which was granted. It was the subsequent service of proceedings on the bank outside New 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.114 The plaintiff argued that, accordingly, KAB 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 KAB 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 KAB 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:1.11'7 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 onlyrights an d 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 offraud 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 AC 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 MD 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] BCC 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] BCC 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] BCC 161 at 162. 126 Re Hydrodan [1994] BCC 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 own 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] BCC 161at 164. 128 They would be acting as an organ of the company in such an event. 129 Re Hydrodan [1994] BCC 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] BCC 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 own 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 PFTZM 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. NR Campbell, 'Liability as a shadow director' (1994) JBL 609 at 613; GK Morse, 'Shadow and de facto directors in the context of proceedings for disqualification on the grounds of unfitness and wrongful trading' in BAK 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 On the issue whether the Humberclyde officers were shadow directors, Judge Paul Baker QC 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 undoubledrights 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 QC 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 New Zealand Dairy Board.141 Dairy Containers Ltd operated as a separate company, although the New 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 New 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 DCL were employed by NZDB. 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. On the other question that arose in Dairy Containers [1995] 2 NZLR 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 EW 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 NZLR 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 DCL they did not as a matter of fact receive directions or instructions from the parent company. They were, as directors of DCL, standing (or sitting) in the shoes of NZDB at the board table, but they had not and did not receive directions or instructions from their employer. Even when a firm instruction from NZDB was made, it was directed at the company and not at the directors.. .Nofiction or artificiality is involved, however, in regarding the directors of DCL as employees of NZDB 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 DCL they were acting on the directions or instructions of NZDB as contemplated in the statutory definition. As its employees, NZDB 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 'AWA case' is not enough: the turning of the screws for directors' (1995) 13 C&SLI 414 at 430-433. 146 Dairy Containers [1995] 2 NZLR 30 at 91. 147 Ibid. Former s 60(1 )(b) (or the current s 9 of the Corporations Act) does not state to whom the directions or instructions must be given. It appears that Thomas J in Dairy Containers [1995] 2 NZLR 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. Infinding tha t 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 NZLR 30 at 91. 149 [1995] 2 NZLR 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 thefirst Australian case in which the courts considered the extended definition of 'director'.155 Pioneer International Ltd (Pioneer) indirectly owned 42% of the shares of Giant Resources Ltd (Giant) and was the most significant shareholder in Giant, with the next most significant shareholder holding 10% 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. Two 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] BCC Ch D 161 at 163. This approach was recently adopted in Re PFTZM Ltd (in liquidation) [ 1995] 2 BCLC 354. 151 [1994] BCC 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 NSWLR 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. On 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. When 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 who 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 NSWLR 290 at 324. Hodgson J followed the decision of Kuwait [1991] 1 AC 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 NSWLR 290 at 324. 213 It is clear that the mere fact that Pioneer owned indirectly 42% 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 As a result it found that Pioneer was a shadow director of Giant. First, although the fact that Pioneer held 42% of the shares in Giant was not on its own conclusive that Pioneer was a shadow director, it gave Pioneer ' effective control', b ecause the next most significant shareholder held 10% 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 allfinancial 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 AC 187 was distinguished on this point: Antico (1995) 3 8 NSWLR 290 at 323-324. See further Baxt, 'One 'AWA 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&SL7 184 at 188. 160 Antico (1995) 38 NSWLR 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 own 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 ACSR 459 {AS Nominees). 215 directors were accustomed to act.169 Mr Windsor (Windsor) was the founder of the AS Group of companies. Two of the companies, AS 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, AS Securities Ltd (Securities). Windsor directly controlled Securities. Securities acted as manager of ASN 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 ASN, 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 ASC argued that Windsor was a (shadow) director of ASN 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 ASN 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 ASN 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 ACSR 459 at 462. The ASC was the predecessor of ASIC, the Australian Securities and Investments Commission. 172 AS Nominees (1995) 18 ACSR 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 on 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 ASN 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 ASN and Ample entered into transactions introduced by Windsor without due deliberation. In some cases, they even acted recklessly. In addition, the directors of ASN 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 may 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 ACSR 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 AS Nominees and Ample as a result of s 60 of the Corporations Law] [now: Corporations Act] does not, in my 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 tofind tha t such person was a director for purposes of the Corporations Law}*] 175 Ibid. 176 Ibid. '" Ibid. mIbid. X19Ibid. 180 Ibid 510. See further RC Schulte, Groups of Companies: The Parent-Subsidiary Relationship and Creditors' Remedies (1999) 198-205. 181 AS Nominees (1995) 18 ACSR 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 ACSR 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 who 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 how 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 AC 187. 188 [1994] BCC 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 may 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 may be required or is accustomed to act'.193 The definition of director has therefore clearly been extended to include persons who 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 may 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 why 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 may be difficult to prove that instructions had been given or some other means used to ensure the compliance of the company.195 On 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. On 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 may 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 ACSR 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 New 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 may not be a requirement for shadow directorship in Australia.210 A wish maybe 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 PMC 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 NSWLR 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 may 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 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 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 may 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 ACLC 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 may 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 creditorrights agains t 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 Two 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 may 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 whom 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 FLR 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 ACLC 1,543 (Tourprint v Bott) at 1,557. Cf Metropolitan Fire Services Pty Ltd v Miller (1997) 23 ACSR 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 therisk o f 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 ACLC 1,651. On the facts, however, the court found that pursuing the holding company in question under s 588V or s 588W 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 ACLC 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 Section 588V(l)(a) of the Corporations Act. 42 See Ch 2 para 2.2. 43 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 me 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 ACLR 203 at 206-207; affirmed at [1984] 2 NSWLR 671. See also Hawkins v Bank of China (1992) 26 NSWLR 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 ACLR 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. 234 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 (NSW) 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' may 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 (NSW) 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 may 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 ACSR 553 at 564, applying Standard Chartered Bank of Australia Ltd v Antico (1995) 38 NSWLR 290 (Antico) and Metal Manufacturers v Lewis (1986) 11 ACLR 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 ACLC 393 (Russell Halpern). 55 In John Graham Reprographics Pty Ltd v Steffens (1987) 5 ACLC 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 ACLC 287; BL Lange & Co v Bird (1991) 9 ACLC 1,015. 56 Russell Halpern (1986) 4 ACLC 393 at 396. In Rema Industries and Services v Coad (1992) 7 ACSR 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 ACLC 390. See also Hamilton v Abbott (1980) 5 ACLR 391. 8 Cf Reed International Books Australia Pty Ltd (t/a Butterworths) v King& Prior Pty Ltd (1993) 11 ACLC 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 may be criticised as follows.61 On 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 who 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 New 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 thefirst 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 NSWLR 562. 70 (1986) 4 ACLC 393. 71 (1992) 26 NSWLR 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 NSWLR 562. 78 (1995) 17 ACSR 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 NSWLR 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 ACSR 741. 82 (1992) 26 NSWLR 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 NSWLR 290. 85 Antico (1995) 38 NSWLR 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 ACLC 2 8 (Pollock) at 4 1. Ipp J, with whom 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 ACLC 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 NSWLR 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 ACLC 28 and Sutherland v Liquor Administration Board (1997) 24 ACSR 176 that a tax liability constituted a 'debt' in the relevant statutory sense and, by implication, that it could be incurred. 95 (1995) 38 NSWLR 290. 96 Ibid 314. (emphasis added). 97 (1996) 20 ACSR 81 (Shepherd) at 89; affirmed (1996) 41 NSWLR 431. 98 Shepherd (1996) 20 ACSR 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 As 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 NSWLR 562. 01 Shepherd (1996) 20 ACSR 81 at 89 102 (1995) 38 NSWLR 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 NSWLR 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. On 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 SM 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 ACLR 371 (Kemish) at 378; Taylor v Carroll (1991) 6 ACSR 255; Pioneer Concrete (Vic) v Stule (1996) 14 ACLC 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] VR 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 ACSR 247 at 254 and Pioneer Concrete Pty Ltd v Ellston (1995) 10 ACLR 289 (Ellston) at 3 01. Palmer J i n Southern Cross v Deputy Commissioner of Taxation (2001) 39 ACSR 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. By 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 own 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 ACSR 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 common 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 ACSR 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 NSWLR 290 at 329; Leslie v Howship Holdings (1997) 15 ACLC 459 (Leslie) at 465-467; and Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430 at 444-445. 120 (1907) 4 CLR 1514. See also Taylor v Carroll (1991) 6 ACSR 255 at 259. 121 Bank of Australasia v Hall (1907) 4 CLR 1514at 1528 (Griffiths CJ). 122(1964)111CLR210. 123/ta/218. 124 (1966) 115 CLR 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 NSWLR 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 ACSR 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 afinal answer . 135 Stoland (1998) 29 ACSR 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 Law 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 thefinancial 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 ACSR 699 at 711. 146 Kemish (1986) 10 ACLR 371 at 378. 147 In Tourprint v Bott (1999) 17 ACLC 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 ACLR 371. 149 Metropolitan v Miller (1997) 23 ACSR 699 at 703. For a consideration of proceedings instituted under s 588M of the Corporations Act, see Stoland (1998) 29 ACSR 130. See also Mullenger v Dana Australia Pty Ltd, unreported, [1998] VSCA 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 may 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, RP 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 ACLC 1,543 at 1,555, relying on Kemish (1986) 10 ACLR 371 at 378 and Dunn v Shapowloff [1978] 2 NSWLR 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 ACLC 946 at 955; and Antico (1995) 38 NSWLR 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 (NSW) 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 may 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 New 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 ACLR 122. 167 Ibid 129. 168 Ibid 130. 169 [1993] 1 VR 423; confirmed by the Full Court of the Supreme Court of Victoria in Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423 at 45 Iff (Morley). 170 Ibid 447. 171/taf448. 172 (1988) 13 NSWLR 315. In the context of s 556(2)(b) of the Companies Code Ormiston J in Morley [1993] 1 VR 423 adopted a much wider version of the test than Hodgson J at first instance in Metal Manufacturers (1986) 11 ACLR 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. Infinding tha t 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 offirst instanc e 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 may 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 may 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 whom 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 ACLC 946. 189 Morley [1993] 1 VR 423 at 448. 190 Ibid. 191 (1995) 17 ACSR 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 may have arbitrary results because of the requirement of non-participation in management at the time when the debt was incurred.194 The defence may 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 588M 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 Down Under' in J Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (1994) at 510. 198 (1999) 17 ACLC 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 truefinancial situatio n 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'sfinancial situatio n 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 on 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 ACLC 1,543 at 1,555-1,556. 203 Tourprint v Bott (1999) 17 ACLC 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 receivedfinancial reports on a monthly basis on that capacity. 207 Tourprint v Bott (1999) 17 ACLC 1,543 at 1,556. 208 Playcorp Pty Ltd v Shaw (1993) 11 ACLC 641. 209 Androvin v Figliomeni (1996) 14 ACLC 1,461. 210 Tourprint v Bott (1999) 17 ACLC 1,543 at 1,556. 211 (1999) 17 ACLC 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 DCT 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 DCT claimed that the payments were not voidable. The DCT further sought a declaration that the directors of SCI were liable to indemnify the DCT pursuant to s 588FGA(2) of the Corporations Act for all payments that the DCT 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 DCT that resulted in the DCT claim against them. In the final instance Mrs Clarke argued that she had a defence to the claim by the DCT 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 ACSR 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 who 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 may 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 ACLC 1,543. 226 (2001) 39 ACSR 305. 27 Explanatory Memorandum para 1086. (2001) 39 ACSR 305. See also S Pascoe, 'Insolvent trading: director uses Garcia defence' (2002) 13 JBFLP 47'. 229 (1998) 194 CLR 395. 230 Southern Cross (2001) 39 ACSR 305 at 333. 231 (2001) 39 ACSR 305. 232 (1999) 17 ACLC 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 infinancial 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 may 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, may 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. CASAC 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 ACLC 511; Kenna (1999) 32 ACSR 430 and Tourprint v Bott (1999) 17 ACLC 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 may be prejudicial to creditors.240 Those creditors who have dealt with the most viable company in the group may 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 who have diligently ensured that they contract with a particular group company may 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 may pose a problem, since business activities with a higher than usual risk of failure may be organised to avoid falling within such definition. • Another limitation is that the insolvent trading provisions may 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 CASAC is that the insolvent trading provisions do not cover debts that the subsidiary incurred while it was still CASAC 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 CASAC 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 may 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 may 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, CASAC 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 CASAC recommendations in this regard may 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 CASAC 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 CASAC proposal in this regard and for suggestions. 249 See Ch 10 para 10.2. 268 An important limitation of the insolvent trading provisions that CASAC 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 NSWLR 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 By importing the phrase 'incurring an obligation' into the legislation, the interpretation problem that has arisen in Australia has been transposed into the New Zealand law. Of 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 thefinancial 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 NZLR 96. 257 TGW 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 VCS 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 New Zealand law are discussed in H Rennie and P Watts, Directors' Duties and Shareholders' Rights, New 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 New 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 UK 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 UK 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 LS 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 Law 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 New 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 Law 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 CO 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 CO 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 ASC 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 may 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 New 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 may 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 CO 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 CO 98/1418, above n 3, Condition (l)(i). 14 'Closed Group' is defined in CO 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 CO 98/1418, above n 3, Editorial Note 28. 275 The Deed of Cross Guarantee contemplates the appointment of a company as trustee who will hold on behalf of creditors the benefit of the covenants made by the other parties to the deed. The trustee maybe a related company.17 If, however, the trustee is a Group Entity,18 it will be necessary to appoint two trustees. Thefirst truste e 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 thefirst 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 CO 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 CO 98/1418, above n 3, Editorial Note 25. ASC Media Release 91/64, Public Hearing: Accounting relief for wholly-owned subsidiaries, para 3. CfFL Clarke and GW 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 NCSC 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 An ASC Class Order issued on 19 December 1991 replaced NCSC 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 ASC issued a revised consolidated CO 95/1530 replacing earlier class orders. In 1998 ASIC replaced CO 95/1530 with CO 98/1418. 25 For more detail on previously existing problems, see ASC 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 ACSR 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 GW Dean, PF Luckett and E Houghton, 'Notional Calculations in Liquidations Revisited: The Case of the ASC 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 NCSC 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 NSCS 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 thefirst 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. SBNSW 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 SBNSW 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 SBNSW receiving a significantly lower dividend than other creditors of the Westmex group if all the loans made by SBNSW 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. SBNSW 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 ACSR 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? On the second question, McLelland J regarded it as unnecessary to consider mathematical procedures: see Westmex (1992) 8 ACSR 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 ASC 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 ACSR 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 New 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 NCSC 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 ACLC 106 at 109-110. 41 See Re Egnia Pty Ltd (in liq) (1992) 10 ACLC 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 PD 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 may 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. On the basis hereof the debtor and its wholly-owned entities which are parties to the Deed of Cross Guarantee may 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 may 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 CASAC 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 may 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 may 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. Thefirst reason is that the directors may be in breach of theirfiduciary duty by committing their company to a Deed of Cross Guarantee or by joining the revocation of the Deed of Cross Guarantee. The relevantfiduciary dut y 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 CASAC 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 Ch 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 ASC in its Issues Paper to the Public Hearing on Deeds of Cross Guarantee: '[I]t could be argued that if afinancially sound subsidiary enters into a deed to which lessfinancially robust subsidiaries are also party, this could in certain circumstances prejudice the interests of both shareholders and creditors of thefinancially 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. QAL, 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 theirfiduciary dut y 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 ASC Media Release 91/64, above n 22, para 11. 53 (1990) 2 ACSR 307, confirmed on appeal [1991] 2 Qd 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 itsfinancially les s viable subsidiaries. See further Ch 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 QAL as controlling shareholder of each subsidiary company entered into the deeds with ANZ. 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 QdR 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 offiduciary dut y 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 ASC 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 NCSC 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 How 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 NCSC 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. 64(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 theirfiduciary dutie s 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 ACLC 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 who 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 may 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. Thefirst typ e 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 may 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 CLR 245 (Sunbird Plaza). 72 See further AD Brown, 'Does section 592 apply to guarantees? Therisks increase after the Hawkins case' (1993) UC&SU34. 73 (1992) 7 ACSR 262. 74 (1992) 26 NSWLR 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 On 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 ACSR 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 CLR 245. 78 Bank of China v Hawkins (1992) 7 ACSR 262 at 266. In this regard Rogers CJ referred to NRG Vision Ltd v Churchfield Leasing Ltd (1988) 4 BCC 56. 79 Bank of China v Hawkins (1992) 7 ACSR 262 at 270. See further A Herzberg, 'Insolvent Trading' (1991) 9 C&SLJ 285 at 295. 80 Hawkins v Bank of China (1992) 26 NSWLR 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 ACLC 62 at 64. 90 Ibid. 91 Ibid. 92 Following Plowman J in Re Trix Ltd [1970] 3 All ER 397. 93 Austcorp Tiles (1992) 10 ACLC 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] BCLC 106; confirmed on appeal [1993] BCLC 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 ER 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. BCCI 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 BCCI (Overseas), went into insolvent liquidation. The liquidators of BCCI (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 BCCI (SA), should contribute to the funds available to creditors. There would be a mutual release of claims between the BCCI 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 BCCI (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 who had different interests, it was impractical to convene any meetings to this end. The affairs of BCCI (S A) and BCCI (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 AE Goodwin Ltd (G). H executed deeds charging its undertaking and assets in favour of TEA Nominees Ltd (TEA) as trustee for debenture holders. All sixteen subsidiaries guaranteed payment to TEA 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. TEA subsequently appointed a receiver in respect of H and each of the sixteen subsidiaries. The receiver eventually realised the group's assets and paid TEA 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. Of 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. Of 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 how 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 no difficulty in accepting that, before a surety is, or sureties are, entitled to be subrogated to therights o f 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 my 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 who had paid more than his due proportion was entitled, as a means of enforcing hisright t o 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 common liability.117 Thirdly, theright o f subrogation was in the nature of a classright, 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'srights agains t 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 common 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] BCLC 363. 22 See O'Donovan, above n 63, 62-63. 23 [1985] BCLC 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. He could accordingly enforce any securities that the creditor possessed against his co-sureties in order to obtain contribution. As between co-sureties who 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 As 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 aright t o 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 RP Meagher, WMC Gummow and JRF Lehane, Equity: Doctrines and Remedies (1992), particularly para 1106. 128 Brown v Cork [1985] BCLC 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) An order may be made subject to conditions. (4) An 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 ACLR 481. 131 [1985] BCLC 363 132 Other accounts would be, eg, trading accounts, which are quite separate from the guarantees. 133 [ 1985] B CLC 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 ACSR 79; Mentha v GE Capital (1998) 16 ACLC 1,032 (Mentha). 297 The fact that liquidators of group companies may 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 may therefore allow pooling in a more flexible and less expensive way than under a scheme of arrangement. CASAC 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. No one present dissented.142 136 Section 436B of the Corporations Act. CASAC 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 ACSR 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 New 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 ACSR 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 ACSR 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 ACSR 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] BCLC 106; [1993] BCLC 1490. 146 Dean-Willcocks (1997) 24 ACSR 79 at 85. See the discussion of BCCI (No 3) [1993] BCLC 106; [1993] BCLC 1490 in para 8.3.1 above. 147 Dean-Willcocks (1997) 24 ACSR 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 NSWLR 299 appropriate about how 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 An 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 ACSR 79 at 85. It should be noted that the judgment of Young J contained no reference to Austcorp Tiles (1992) 10 ACLC 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; AR Keay, 'Voluntary administrations: the convening and conducting of meetings' (1996) 4 Insol Law Jnl 9. 149 (1997) 42 NSWLR 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 ACSR 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 DIM 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 DIM 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 NSWLR 209. 158 (1997) 25 ACSR 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 who 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. When 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 DIM 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 DIM group, Finkelstein J stated:171 In my 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 ACLC 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 ACLC 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) An 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 ACSR 337. 174 Mentha (1998) 16 ACLC 1,032 at 1,037. 175 (2000) 35 ACSR 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 ACSR 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. An 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 When 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. Thefirst 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 ACSR 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 ACSR 172 at 173. 186 This was basically the approach followed in BCCI (No 3) both in [1993] BCLC 106 and [1993] BCLC 1490 but without recourse to any UK 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 ACSR 172 at 175. In Australasian Memory Pty Ltd v Brien (2000) 172 ALR 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 ACSR 172 at 177-178. 190 Ibid 177. 191 Ibid 178. 192 [1993] BCLC 106; [1993] BCLC 1490. 193 Ibid. 194 Switch Telecommunications (2000) 35 ACSR 172 at 178. Ibid 178-9. In this regard there was an implicit departure from/?e Albert Life Assurance Company (1871) LR 6 Ch App 381 in Re BCCI (No 3) [1993] BCLC 106; [1993] BCLC 1490. 196 [1993] BCLC 106; [1993] BCLC 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 p993] BCLC 106; [1993j BCLC 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. Thefirst 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 ACSR 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 who 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 ACLC 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 dut y to act bonafide i n 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 QdR360. 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 may 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 may 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 Ch 246 at 298. 236 See the discussion in para 8.2.2.1(b) above. 237 An 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 ACSR 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 On 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 may 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 New 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 arises 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 DIM 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 may cause problems in the sense that a new category of arrangement binding on creditors may 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 NSWLR 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 may 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 may 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 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 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 New 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] AC 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 May 2000 CASAC 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. CASAC Final Report, above n 6, Recommendation 23. CASAC 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 (CASAC 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 New 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 New 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 gaverise t o 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 ALRC Report, General Insolvency Inquiry, Report No 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 Law 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 ALRC 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 ALRC 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 ALRC 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. CASAC 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 ALRC therefore did not accept that its proposal would cause uncertainty. Furthermore, the ALRC 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 ALRC 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. As 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 who 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 CASAC 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- groupfinancial 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. An 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 CASAC Final Report, above n 6, para 6.43. Ibid. See further RP 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 ALRC proposed that the court should be able to make such an order in two situations. Thefirst i s 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 ALRC 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 Ch 10 para 10.2. 24 Harmer Report, above n 9, para 857. This is similar to the pooling provision in New Zealand discussed in para 9.3 below. 25 Discussion Paper No 32, above n 9, para 564-5 and Harmer Report, above n 9, para 854-7. Again, this is similar to the New 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 (WA). 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 New 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 New 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 noright t o 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 afiduciary 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 afiduciary 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) On 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, Cmnd 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 CASAC recommendations. There is, however, scant authority on even the basic ambit of the New Zealand provisions relating to contribution and pooling. In particular, the New Zealand courts have had little opportunity so far to analyse the provisions dealing with contribution orders. The cases where the New 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 thinksfit' ha d 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. On 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 New Zealand courts have held that an order for full contribution may be inappropriate if such an order would place in jeopardy the solvency of the related company not in liquidation. It follows that in New Zealand a contribution order may only be levied against the balance of the CASAC 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) BCR 604. (1988) 4 NZCLC 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 New Zealand. Altherm Aluminium (Auckland) Limited (in liq) (Altherm Auckland) and Altherm Aluminium (Waikato) Limited (Altherm Waikato) w ere related c ompanies holding rights under afranchise agreemen t to deal with aluminium products under the name 'Altherm'. Both companies manufactured the same goods. When 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 New 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 thefirst time in HEB Contractors Ltd v Westbrook Development Ltd.4* HEB 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 HEB Contractors in the name of Westbrook Heights Ltd (Westbrook Heights) rather than Westbrook Development. HEB 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' CLE 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 NZCLC 262, 256 (HEB Contractors v Westbrook). 332 name when it executed thefinal documents. HEB Contractors carried out the work on property owned by Westbrook Development. Westbrook Development made certain progress payments due under the contract between HEB 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. HEB Contractors sought an order pursuant to s 271(l)(a) that Westbrook Development should pay to the liquidator of Westbrook Heights moneys outstanding to HEB 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). Thefirst 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 HEB Contractors. His Honour also found that Westbrook Development received all the benefits from the subdivision work completed by HEB 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. HEB 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 HEB 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 why 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 HEB Contractors to continue with its performance of the contract; • the directors of Westbrook Development transferred other assets relevant to the work carried out by HEB Contractors to other companies in which they had interests, rather than to Westbrook Heights, without disclosure to HEB 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 tow 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 HEB Contractors, its failure to fund Westbrook Heights so that it could meet its obligations to HEB Contractors amounted to circumstances that gaverise 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 thinksfit'. Th e 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 HEB 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 HEB Contractors. This, in turn, encouraged HEB 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 New 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 therights 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 may include only assets, but it may 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 NZLR 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 ACLR 481 and Brown v Cork [1985] BCLC 363 discussed in Ch 8 para 8.3.2.1. 66 [1991] 2 NZLR 296. 67 (1991) 5 NZCLC 67,137 (Re Stewart Timber & Hardware). 68 (1991) 5 NZCLC 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 Two 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 NZCLC 64,757 (Re Pacific Syndicates) at 64,767-64,768. 74 CfBullen v Tourcorp Developments Ltd (1988) 4 NZCLC 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 hasfinally com e 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' Thefirst facto r 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 NZCLC 64,757 at 64,767. 77 Ibid 64,161-64,168. 78 [1991] 2 NZLR 296. 79 The phrase 'just and equitable' was also considered in Re Home Loans Fund (NZ) Ltd (in group liq) (1983) 1 NZCLC 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 NZLR 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 who 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 gaverise 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 giverise 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 common 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 thinksfit'. 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. As 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 New Zealand only, because the United States and United Kingdom 96 Re Dalhoff [1991] 2 NZLR 296 at 306. 57 Ibid. See further the discussion of AE Goodwin Ltd v AG Healing Ltd (1979) 7 ACLR 481 and Brown v Cork [1985] BCLC 363 in the context of inter-company debts in Ch 8 para 8.3.2.1. 98 Re Dalhoff [1991] 2 NZLR 296 at 306-307. 99 Ibid. 100 Ibid. It should be noted that Hardie Boys J in Re Pacific Syndicates (1989) 4 NZCLC 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, CASAC reiterated that it did not support a general court contribution order power.107 As far as employee entitlements were concerned, CASAC 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 CASAC CASAC 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 CASAC 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 CASAC 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 New Zealand as well as that in the United States. In discussing the New Zealand position, CASAC pointed out that, before granting a pooling order, New 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 New 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 CASAC 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'. CASAC 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 CASAC 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, CASAC stated that such 'uncertainty problem' already existed under s 588V of the then Corporations 1 0(\ Law. CASAC was of the view that a clearer balance of interests and reduced uncertainty in pooling could be achieved by providing that: • therights 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 CASAC 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, CASAC 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 CASAC Final Report, above n 6, para 6.91. 118 This was an unfortunate choice of word by CASAC, as it blurs the distinction between contribution and pooling. See further the discussion in para 9.6.2.2 below. 119 CASAC 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 CASAC 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 New 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 CASAC stated that it continued to support Draft Recommendation 23, which adopted the principles set out in the Harmer Report.126 CASAC 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 CASAC 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: CASAC Final Report, above n 6, Recommendation 22. CASAC Final Report, above n 6, para 6.97. CASAC 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: CASAC Final Report, above n 6, para 6.98. 346 • make it clear that pooling orders do not affect therights o f 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 CASAC 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 New Zealand example.131 One of the reasons proffered by CASAC 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 CASAC Final Report, above n 6, Recommendation 23. 129 [1897] AC 22. 130 Above n 6, Recommendation 21. 131 Above n 6, Recommendation 23. It is interesting to note that CASAC would not support the introduction of any form of contribution order of the kind used in New Zealand, while it had no qualms about adopting the New Zealand pooling order, which is arguably a more drastic deviation from the rule in Salomon v Salomon [1897] AC 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 New 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 New Zealand provisions will cause uncertainty. This is equally true of the New Zealand pooling orders. When comparing the factors to be taken into account for New 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 New 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. CASAC 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 New 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. An example of such advertising is where an individual subsidiary is referred to as 'part of the ABC 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 On occasion, however, the unthinkable does happen, and the holding company decides not to support its subsidiary infinancial 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 NC 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. Thefirst situatio n arises where one company participates in the management of another but where the respective companies have their own 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 may 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 may 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'). On 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 may 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 CASAC 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 givingrise t o 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 CASAC 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 CASAC's recommendation that contribution orders should not be allowed in Australia. Both contribution and pooling orders may giverise t o 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 New 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 may 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 may 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] AC 22 (Salomon v Salomon). 5 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34. 6 [1897] AC 22. 7 IM Ramsay and GP 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: CASAC 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. As 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 move 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 CLR 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 ACLC 1172. 11 (1976) 137 CLR 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 thefiduciary 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 theirfiduciary 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 CASAC, 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 Ch 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 may 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 New 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, OE Williamson, 'The modem 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 As 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 may 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 who is not a creditor of a particular company may 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 CASAC 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, CASAC suggests that Australia should adopt the New Zealand pooling order. However, great uncertainty surrounds the New Zealand pooling provisions, which is exacerbated by the considerable overlap between the factors to be taken into account for contribution and pooling in New 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 CASAC are concerned, CASAC 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: To be used as a last resort In Chapter 9 it was pointed out that one of the reasons proffered by CASAC 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 CASAC endorses. It was further pointed out that the uncertainty in relation to the New 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 CASAC 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, Cmnd 8558 (1982) (Cork Report). Thefirst one, ie the one that forms the subject matter of this thesis, is about liability to external creditors. CASAC 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 CASAC refers to 'solvent' here, but then only provides an answer in the circumstances where all the companies are insolvent, ie pooling. CASAC does not state what should be in the place of the New 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, CASAC 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. As 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 New 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 may be granted in this way would not only a void the current confusion between New 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 CASAC and referred to in Chapter 9, namely, that the loss is arbitrary or random and therefore not necessarily fair.34 31 (1989) 4 NZCLC 64,757. This case is discussed in Ch 9 para 9.5.2. 32 Also, in Re Capital Project Homes Pty Ltd (1991) 6 ACSR 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 CASAC 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 efficientrisk-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. Thefirst avenu e 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 common 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 toorigid. Th e 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. CASAC 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 Ch 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 owe 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 Law 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 Ch 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. An 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 CfCASAC 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 ER 462 and Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 QB 358 were based on the distinction made by Denning MR 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 may be exercised in different ways. Some subsidiaries may be managed at arms' length while others may be managed under tight supervision. Within the same subsidiary some functional areas may be under tight control while others are not. Even within the same functional areas the managers of the subsidiary may make some decisions autonomously, while others may 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 arigid 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 may 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 DS 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 BC 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 USC, 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 NSW 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 New 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 CERCLA applies to those who 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, CERCLA 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 CERCLA now 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 unsecuredright 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 (WA). 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 much 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 RA 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 thefirst 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 An 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 may 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] AC 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) LR 5 Ch App 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 FLR 290; Pt Garuda Indonesia Ltd v Grellman (1992) 107 ALR 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 an d 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 may 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 UK 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 (thefirst body') if:85 (a) the second body controls the first body as contemplated in s 46A; and (b) thefirst body becomes insolvent (or an insolvency event occurs in respect of thefirst 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 thefirst 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 thefirst 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 NSWLR 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 CLR 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. As 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 New Zealand is concerned, there is also nothing in the Companies Act 1993 (NZ) expressly providing for this contingency, but the New Zealand courts have held that contribution orders are available only where the holding company remains solvent. The New 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 New 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 New 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 who 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 New 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 CASAC 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 CASAC 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 may 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 CASAC 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 Ch 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 CW 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 theright 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 may run the affairs of its subsidiary according to its own 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] BCLC 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 CASAC 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 New 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 New Zealand model,111 contribution 109 See CASAC Final Report, above n 8, para 6.28 and Ch 7 para 7.4.2. 110 While the CASAC 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 New 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 New 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 may rebut the presumption, the loss is borne by theright entit y 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 New Zealand, there has not been undue uncertainty and it also has not discouraged entrepreneurial activity. D Goddard, 'Directors and Corporate Groups - the New 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, NSW, 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 isfree t o 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 CASAC, 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 RM 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 EEC 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. SK Miller, 'Piercing the corporate veil among affiliated companies in the European community and in the US: a comparative analysis of US, German, and UK 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. An important reason is that, if the holding company does not enjoy limited liability, desirable butrisky ventures may 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 may 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 Mr 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 CL 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 RP 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. As 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 TABLE OF CASES 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 QdR 360 ASC v AS Nominees Ltd (1995) 18 ACSR 459 ASC v Gallagher (1993) 11 WAR 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 All ER 769 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 liq)(No 3), unreported, SC NSW, 50441/1989, Cole J, 14 December 1990 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 ofAustralasia 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 WN (Pt 1) (NSW) 307 Bentley Poultry Farm Ltd v Canterbury Poultry Farmers Association (1989) 4 NZCLC 64,780 Berkey v Third Ave Ry 244 NY 84, 155 NE 58 (1926) Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 BL Lange &Cov Bird (1991) 9 ACLC 1,015 Bluebird Investments Pty Ltd v Graf'(1994 ) 13 ACSR 271 Bluecorp Pty Ltd (in liq) formerly Lloyds Ships Holdings Pty Ltd (in liq) v ANZ Executors Trustee Co Ltd (1994) 13 ACSR 386; (1995) 18 ACSR 566 Bond Brewing Holdings Ltd v National Australia Bank Ltd (1990) 1 ACSR 445 Bond Corporation Holdings Ltd, Re (1990) 1 ACSR 350 Bonollo,Rv [1981] VR 633 Boulton v Association of Cinematography, Television and Allied Technicians [1963] 2 QB 606 Brady v Brady [1988] BCLC 20 (CA) Bray v F Hoffman-La Roche Ltd, unreported, [2002] FCA 243, Merkel J, 13 March 2002 386 Breckland Group Holdings Ltd v London & Suffolk Properties Ltd (1988) 4 BCC 542 Brick & Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1991) 9 ACLC 324 Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549 British Eagle International Airlines Ltd v Compagnie Nationale Air France Ltd [1975] 1 WLR 758 Broadcasting Station 2GB Pty Ltd, Re [1964-5] NSWR (SC) 1648 Broderip v Salomon [1895] 2 Ch 323 Brow, Rv [1981] VR 783 Brown v Cork [1985] BCLC 363 Bullen v Tourcorp Developments Ltd (1988) 4 NZCLC 64,661 Byron v Southern Star Group Pty Ltd (1996) 22 ACSR 553 Calzaturificio Zenith Pty Ltd (in liq) v NSW Leather and Trading Co Pty Ltd [1970] VR 605 Capital Project Homes Pty Ltd, Re (1991) 6 ACSR 310 Capricorn Society Ltd v Linke (1995) 17 ACSR 101 Carrier Air Conditioning v Kurda (1993) 11 ACSR 247 Castrisios v McManus (1991) 9 ACLC 287 Charter Travel Co Ltd, Re (1997) 25 ACSR 337 Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 Ch 62 Chemical Bank NY Trust Co v Kheel 369 Y2& 845 (2d Cir. 1966) Chen v Butterfield (1996) 7 NZCLC 261,086 City Equitable Fire Insurance Co Ltd, Re [1925] Ch 407 Coleman, Re (1888) 39 Ch D 443 Collins Marrickville Pty Ltd v Henjo Investments Pty Ltd (1987) ATPR para 40-783 Commercial Envelope Manufacturing Company, In re 14 Collier Bankr. Cas. (MB) 191 (S.D.N. Y. 1977) Commissioner of State Taxation (WA) v Pollock (1994) 12 ACLC 28 Commissioners ofInland Revenue v Sansom [1921] 3 KB 492 Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946 Contal Radio Ltd, Re [1932] 2 Ch 66 387 Creasey v Breachwood Motors Ltd [1993] BCLC 480 Dairy Containers Ltd v NZIBank Ltd [1995] 2 NZLR 30 Dalhoff & King Holdings Ltd, Re [1991] 2 NZLR 296 Daniels v Anderson (1995) 13 ACLC 614 Day-Nite Carriers Ltd (in liq), Re [1975] 1 NZLR 172 Dean-Willcocks v Soluble Solution Hydroponics Pty Limited (1997) 42 NSWLR 209 Demondrille Nominees Pty Ltd v Shirlaw (1997) 15 ACLC 1,716 Dennis Wilcox Pty Ltd v Federal Commissioner of Taxation (1988) 14 ACLR 156 DHN Food Distributors Ltd v Tower Hamlets LBC [1976] 3 All ER 462 DIM Furniture (Vic) Pty Ltd v AKZO Nobel Casco Products GmbH, unreported, Supreme Court, Victoria, Hansen J, 16 November 1997 D'Jan of London Ltd, Re [1994] 1 BCLC 561 Dronfield Silkstone Coal Co, Re (1881) 17 Ch D 76 Duke Group Ltd (in liq) v Pilmer (No 2) (2000) 78 SASR 216 Dunn v Shapowloff [1978] 2 NSWLR 235 Eastgroup Properties v Southern Motel Association Ltd 935 F.2d 245 (11 Cir.1991) ED White Ltd, Re (1929) 29 SR (NSW) 389 Egnia Pty Ltd (in liq), Re (1992) 10 ACLC 185 Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 11 ACLC 952 Equiticorp Financial Services Ltd (NSW) v Equiticorp Financial Services Ltd (NZ) (1992) 9 ACSR 199 FAI Traders Insurance Co Limited v Ferrara (1996) 41 NSWLR 91 Farmers' Freehold Land Co Ltd, Re (1892) 3 BC (NSW) 39 Farrow Finance Co Ltd (in liq) v Farrow Properties Pty Ltd (in liq) (1997) 26 ACSR 544 Fatupaito v Bates (2001) 9 NZCLC 262,583 Federal Deposit Insurance Corporation v Bier man 2 F3d 1424 (1993) (Seventh Circuit) Fenton; Ex parte Fenton Textile Association (No 2), Re [1932] 1 Ch 178 FG (Films) Ltd, Re [1953] 1 WLR 483, [1953] 1 All ER 615 388 Fitzroy Football Club Ltd v Bondborough Pty Ltd (1997) 15 ACLC 638 Fitzsimmons v R (1997) 23 ACSR 355 Flavel v Semmens (1987) 5 ACLC 868 Foss v Harbottle (1843) 2 Hare 461 Francis v United Jersey Bank 432 A 2d 814 (1981) Gamble v Hoffmann (1997) 24 ACSR 369 Garcia v National Australia Bank (1998) 194 CLR 395 Gilford Motor Co Ltd v Home [1933] All ER Rep 109 Ghosh, R v [1982] 2 All ER 689 Grantham, R v (1984) 1 BCC 99,075 Gray Eisdell Timms Pty Ltd v Combined Auctions Pty Ltd (1995) 17 ACSR 303 Grazing and Export Meat Co, Re (1984) 2 NZCLC 99,226 Group Four Industries Pty Ltd v Brosnan (1992) 8 ACSR 463 Grove v Flavel (1986) 43 SASR 410 HagenvalePty Ltd vDepela Pty Ltd & Serrada Holdings Pty Ltd (1995) 17 ACSR 139 HallamvRyan (1990) 5 NZCLC 66,123 Hamilton v Abbott (1980) 5 ACLR 391 Hardie v Hanson (1959-1960) 33 ALJR 455 Harris v S (1976) 2 ACLR 51 Harvey, R v [1993] 2 Qd R 389 Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd [1969] 2 NSWR 782 Hawkins v Bank of China (1992) 26 NSWLR 562 Hay's Settlement Trust, Re 1982 1 WLR 202 HEB Contractors Ltd v Westbrook Development Ltd (2000) 8 NZCLC 262, 256 Heide Pty Ltd t/a Farmhouse Smallgoods v Lester (1990) 3 ACSR 159 Heron International Ltd v Lord Grade (1983) BCLC 244 Heytesbury Holdings Pty Ltd v City ofSubiaco (1998) 19 WAR 440 Hilton International Ltd v Hilton [1989] 1 NZLR 442 Hogg v Cramphorn Ltd [1967] Ch 254 Home Loans Fund (NZ) Ltd (in group liq), Re (1983) 1 NZCLC 95,073 389 Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41 Hotel Terrigal Pty Ltd v Latec Investments Ltd (No 2) 1969] 1 NSWR 676 Hussein v Good (1990) 8 ACLC 390 Hutton v West Cork Railway Co (1883) 23 Ch D 654 Hydrodan (Corby) Ltd, Re [1994] BCC Ch D 161 Hymix Concrete Pty Ltd v Garrity (1977) 13 ALR 321 In Re Bank of Credit and Commerce International SA (No 3,) [1993] BCLC Ch D 106; [1993] BCLC 1490 In Re Horsley & Weight Ltd [1982] 3 WLR 431 In re Smith and Fawcett Ltd [1942] 1 Ch 304 In re White and Osmond (Parkstone) Ltd, unreported (30 June 1960) Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 Iraqi Ministry of Defence v Arcepey Shipping Co SA (Gillespie Bros & Co Ltd Intervening), The Angel Bell [1980] 1 All ER 480; [1981] QB 65 James Hardie & Co Pty Limited v Putt Matter, unreported, [1998] NSW Supreme Court 434 (22 May 1998) Japan Abrasive Materials Pty Ltd v Australian Fused Materials Pty Ltd (1998) 16 ACLC 1172 Jeffree v NCSC [1990] WAR 183 Jelin Pty Ltd v Johnson (1987) 5 ACLC 463 JN Taylor Holdings Ltd (in liq) (No7), Re (1991) 6 ACSR 187 John Graham Reprographics Pty Ltd v Steffens (1987) 5 ACLC 904 Jones v Lipman [1962] 1 WLR 832 Joshua Shaw, Re (1989) 5 BCC 188 Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430 Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 Kitay v Strathfield Holdings Pty Ltd (1998) 27 ACSR 716 Konica Australia Pty Ltd v Aprolab Flashpoint (Australia) Pty Ltd (1999) 17 ACLC 1,651 Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1990] 3 All ER 404 390 Lam Soon Australia Pty Ltd (administrator appointed) v Molit (No 55) Pty Ltd (1996) 22 ACSR 169 Lawrence v Jacobson (2001) 9 NZCLC 262,477 Leigh-Mardon Pty Ltd v Wawn (1995) 17 ACSR 741 Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459 Levin v Clark [1962] NSWR 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 Linton v Telnet Pty Ltd (1999) 30 ACSR 465 Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30 Littlewoods Mail Order Stores Ltd v Mc Gregor (Inspector of Taxes) [1969] 3 All ER 855 Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 WLR 627; [1980] 1 QB 358 Love, R v [1989] 17 NSWLR 608 Love v ASC (2000) 36 ACSR 363 Lyford v Commonwealth Bank of Australia (1995) 130 ALR 267 Marchesi v Barnes [1970] VR 434 Maritime Union of Australia v Patrick Stevedores No 1 Pty Ltd (1998) 27 ACSR 497 MC Bacon Ltd, Re [1990] BCLC 324 McDonald v Hanselmann (1998) 28 ACSR 49 McKenzie v Gianoutos & Booleris [1957] NZLR 309 McMahon v Pomeray Pty Ltd (1991) ATPR para 41-125 McPhail v Doulton [1971] AC 424 Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 17 ACSR 187 Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152 Mentha v GE Capital (1998) 16 ACLC 1,032 Metal Manufacturers v Lewis (1986) 11 ACLR 122; (1988) 13 NSWLR 315 Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 Miller v Miller (1995) 16 ACSR 73 Morley v Statewide Tobacco Services [1993] 1 VR 423 391 Mount Edon Gold Mines Ltd v Burmine Ltd (1994) 12 ACSR 727 Mullenger v Dana Australia Pty Ltd, unreported [1998] VSCA 30 (27 August, 1998) Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] 3 WLR 492 National Australia Bank Ltd v Bond Brewing Holdings Ltd [ 1990] 169 CLR. NCSC v Brierly Investments Ltd (1988) 14 ACLR 177 New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler, Re (1994) 122 ALR 531 New Zealand Guardian Trust Co Ltd v Brooks [1995] 2 BCLC 242 (PC) Nicholas v Soundcrafi Electronics [1993] BCLC 360 Nicholson v Permakrafi (NZ) Ltd (in liq [1985] 1 NZLR 242 Nippon Express (NZ) Ltd v Woodward, Re Horticultural Handling Ltd (1998) 8 NZCLC 261,765 Noakes v J Harvey Holmes & Sons (1979) 37 FLR 5 Norfolk Plumbing Supplies Pty Ltd v Commonwealth Bank of Australia (1992) 6 ACSR 601 Northside Developments Pty Ltd v Registrar General (1990) 176 CLR 146 NRG Vision Ltd v Churchfield Leasing Ltd (1988) 4 BCC 56 Official Assignee v 15 Insell Avenue [2001] 2 NZLR 492 Official Trustee v Marchiori (1983) 69 FLR 290 Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447 Oriental Commercial Bank, Re (1871) 7 Ch App 99 Pacific Syndicates (NZ) Ltd (in liq), Re (1989) 4 NZCLC 64,757 Parker vNRMA (1993) 11 ACSR 370 Pascoe Ltd (in liq) v Lucas (1998) 27 ACSR 737; (1999) 33 ACSR 357 Patrick and Lyon Limited, Re [1933] Ch 786 Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (1998) 27 ACSR 521; (1998) 27 ACSR 535 Percival v Wright [1902] 2 Ch 421 Permanent Building Society v Wheeler (1994) 12 ACLC 674 Petera Pty Ltd v EAJPty Ltd (1985) ATPR para 40-605 Peters v R (1998) 192 CLR 493 392 Petherick Exclusive Fashions Ltd, Re (1987) 3 NZCLC 99,946 PFTZM Ltd (in liquidation), Re [1995] 2 BCLC 354 Pilmer v Duke Group Ltd (in liq) (2001) 180 ALR 249 Pioneer Concrete (Vic) v Stule (1996) 14 ACLC 534 Pioneer Concrete Pty Ltd v Ellston (1995) 10 ACLR 289 Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1986) 5 NSWLR 254 Playcorp Pty Ltd v Shaw (1993) 11 ACLC 641 Polly Peck International pic (in administration), Re [1996] 2 All ER 433 Powell & Duncan v Fryer & Perry (2001) 37 ACSR 589 Produce Marketing Consortium Ltd (No 2) (1989) BCLC 520 Property Force Consultants Pty Ltd, Re (1995) 13 ACLC 1051 Pt Garuda Indonesia Ltd v Grellman (1992) 107 ALR 199 Qintex Australia Finance Ltd v Schroders Australia Ltd (1991) 9 ACLC 109 Queensland Bacon Pty Ltd v Rees (1965) 115 CLR 266 Quick v Stoland Pty Ltd (1998) 29 ACSR 130 Rea v Barker (1988) 4 NZCLC 64,312 Reed International Books Australia Pty Ltd (t/as Butterworths) v King & Prior Pty Ltd (1993) 11 ACLC 935 Rees v Bank of New South Wales (1964) 111 CLR 210 Reid Murray Holdings Ltd (in liq) v David Murray Holdings Pty Ltd (1972) 5 SASR 386 Rema Industries and Services Pty Ltd v Coad (1992) 7 ACSR 251 Repatriation Commission v Harrison (1997) 24 ACSR 711 Ring v Sutton (1980) 5 ACLR 546 Rivarolo Holdings Pty Ltd v Casa Tua (Sales) Pty Ltd (1997) 24 ACSR 105 Robinson & the Trustee Act 1925, Re [1983] 1 NSWLR 154 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] 1 Ch 246 Royal Brunei Airlines Sdn Bhd v Tan [1995] 3 All ER 97 Russell Halpern Nominees Pty Ltd v Martin & Anor (1986) 4 ACLC 393 Salomon v Salomon & Co Ltd [1897] AC 22 Sandell v Porter (1966) 115 CLR 666 393 Sands & McDougall Wholesale Pty Ltd (In Liq) & Anor v Commissioner of Taxation (Cth) (1999) 1 VR 489 Sass: Ex parte National Provincial Bank of England, Re [1896] 2 QB 12 Savill v Chase Holdings (Wellington) Ltd [1989] 1 NZLR 257 Scottish Co-operative Wholesale Soc Ltd v Meyer [1958] 3 All ER 66 Secretary of State for Trade and Industry v Laing [1996] 2 BCLC 324 Secretary of State v Deverell [2000] 2 BCLC 133 SecuritibankLtd (No 2), Re [1978] 2 NZLR 136 Setco Manufacturing Pty Ltd v Sifa Pty Ltd (1982) 7 ACSR 327 Shapowloff v Dunn (1981) 148 CLR 72 Sheahan v Verco & Anor (2001) 79 SASR 109 Shepherd & Ors v ANZ Banking Corporation Ltd (1996) 41 NSWLR 431 Simionato Holdings Pty Ltd, In the Matter of (1997) 15 ACLC 477 Sinclair, R v (1968) 1 WLR 1246 Smith, Re [192S] 1 Ch915 Smith, Stone and Knight Ltd v Birmingham Corporation [1939] 4 All ER 116 Southard & Co Ltd, Re [1979] 1 WLR 546; [1979] 1 WLR 1198 Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation (2001) 39 ACSR 305 Southern Resources v Residue Treatments (1991) 3 ACSR 207 Southmall Hardware Ltd (in liq), Re (1984) 2 NZCLC 99,102 Soviero v Franklin National Bank 328 F.2d 446 (2d Cir.1964), Sparks v Berry (2001) 19 ACLC 1430 Spedley Securities Ltd (in liq) v Greater Pacific Investments Pty Ltd (in liq) (1992) 7 ACSR 155 Spies v The Queen (2000) 18 ACLC 727 Spreag v Paeson Pty Ltd (1990) 94 ALR 679 Standard Chartered Bank ofAustralia Ltd v Antico (1995) 38 NSWLR 290 Stargard Security Systems Pty Ltd v Goldie (1994) 13 ACSR 805 State Government Insurance Corporation v Pollock (1993) 11 ACLC 839 Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 Stewart Timber & Hardware (Whangarei) Ltd (in liq) v Stewart Timber & Hardware Ltd (in liq), Re (1991) 5 NZCLC 67,137 394 Sunbird Plaza Pty Ltd v Moloney (1988) 166 CLR 245 Sutherland v Liquor Administration Board (1997) 24 ACSR 176 Switch Telecommunications Pty Ltd (in liq), Re (2000) 35 ACSR 172 Sydlow Pty Ltd (in liq) v Melwren Pty Ltd (in liq) (1994) 13 ACSR 144 Tasbian Ltd (No 3), Re [1991] BCC 435 Taylor v Carroll (1991) 6 ACSR 255 Thorby v Goldberg (1964) 112 CLR 597 Tjaskemolen, The [1997] 2 Lloyd's Rep 465 Tosich Constructions Pty Ltd (in liq) v Tosich (1997) 23 ACSR 466 Tourprint International Pty Ltd (in liq) v Bott (1999) 17 ACLC 1,543 TrixLtd, Re [1970] 3 All ER 397 TSB Private Bank International SA v Chabra [1992] 1 WLR 231 Unisoft Group Ltd (No 2), Re [1994] BCC 766 Van Reesema v Flavel (1992) 7 ACSR 225 Vinyl Processors (New Zealand) Ltd v Cant [1991] 2 NZLR 417 Vrisakis v ASC (1993) 9 WAR 395 Wait Investments Ltd (in liq), Re [1997] 3 NZLR 96 Walker v Wimborne (1976) 137 CLR 1 Welfab Engineers Ltd, Re [1990] BCC 600 West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 Westmex Operations Pty Ltd (in liq) v Westmex Ltd (in liq) (1992) 8 ACSR 146; 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