Directors breaching their fiduciary duties: transaction challenged by the receiver

In Allco Funds Management Limited v Trust Co (Re Services) Ltd [2014] NSWSC 1251, an inter-company loan transaction was challenged by a receiver appointed by the secured creditor to one of the companies. Common directors were involved in the transaction. The issue was whether the directors breached their fiduciary duties entitling the company via the receiver to have the transaction set aside.

The background to the case

AFML held 109,687,077 units in a registered management scheme where it had subscribed $1.00 per unit. RFML was the responsible entity for the fund.

For reasons relating to stamp duty, AFML and RFML entered into a loan agreement where AFML lent $109,687,077 to RFML with a fixed repayment date.

RFML used the advance to redeem AFML’s units in the fund. The effect was that AFML’s beneficial equity interest in the fund was converted into a loan.

A variation of the loan was later agreed where the repayment date was postponed with repayment being dependent upon the happening of certain events, which were unlikely to occur in the imminent future.

There were common directors who committed AFML and RFML to the loan agreement and the variation.

AFML subsequently went into liquidation and proceedings were brought by the receiver to set aside the variation.

It was not contended by AFML that the loan was a sham or that it did not reflect the true and actual agreement of the parties or that it was unenforceable according to is terms.

There was no provision in AFML’s articles of association authorising the directors’ conduct and there was no members’ resolution authorising the transactions.

The complaint against the directors

The receiver, on behalf of AFML, argued that:

• the common directors breached their fiduciary obligations to AFML (to the knowledge of RFML) by placing themselves in a position where their duties to AFML conflicted with their duties to RFML;
• the common directors breached their fiduciary and statutory obligations to AFML (with the knowing participation of RFML) that required them to exercise their powers and discharge their duties as directors in good faith, in the best interests of AFML and for a proper purpose; and
• AFML was entitled to an order setting aside the variation and the redemption of the units in the fund.

The decision

The Court made the following findings:

• AFML’s interests, both economic and legal, were not the same as RFML’s.
• Where a director has acted in breach of their fiduciary duty, the fairness or unfairness of the transaction is irrelevant.
• Unless the articles of association of the company otherwise provide, a contract made in breach of the fiduciary duty (to the knowledge of the other party) will be voidable at the option of the company unless the director makes a full disclosure of the nature of their interest in the contract to the members of the company, in general meeting, who must approve the contract by ordinary resolution.
• A provision in the articles of association may validate a contract that would otherwise be voidable under the general law. The director bears the onus of proving there has been strict compliance with such a provision.
• Where there is no relevant provision in the articles of association and the transaction has not been approved by the members of the company in general meeting, it will be rare for a court to infer that there has been informed consent by the company.
• The nature of the conflict was revealed by the dispute. If the variation was set aside, the loan would be repayable to AFML much earlier.
• AFML was entitled to have the variation set aside.
• AFML was also entitled, at its election, to have the loan agreement set aside and its units reinstated.

Although it was not necessary, the Court also considered the statutory duties owed by the directors of AFML and concluded that the directors had also breached their statutory duties.

Comments

Where a director has acted in breach of their fiduciary duty, the fairness or unfairness of the transaction is irrelevant.

Where, for example, a transaction is proposed between related entities, common directors need to be aware of their conflicting fiduciary duties and the steps they should take to comply with their duties.

A contract made in breach of the fiduciary duty will be voidable at the option of the first company unless the director makes a full disclosure of the nature of their interest in the contract to the members of the company, in general meeting, who must approve the contract by ordinary resolution.

Alternatively the director or directors should disclose their interest in the matter and leave the directors’ meeting whilst the matter is discussed and a vote is taken. If the directors are the only directors, the matter must be referred to the members with full disclosure of any detriment to the company, their interest, and the details of the benefits to be gained by the other company.

Where the company is a wholly owned subsidiary, it is permissible for the constitution of the subsidiary to expressly authorise a director to act in the best interests of the holding company, subject to section 187 of the Corporations Act, which requires a director to act in good faith in the best interests of the holding company and which provides that the subsidiary must not be insolvent or become insolvent because of the director’s act.

The decision in Allco gives a warning that suspect transactions are capable of being attacked by receivers or liquidators.

Section 237 of the Corporations Act also enables a member, former member, or person entitled to be registered as a member of the company or of a related body corporate to seek leave from the Court to bring a derivative action on behalf of the company where it is probable that the company will not itself bring the proceedings. This commonly occurs where it is alleged the directors have done something in breach of their duties or acted contrary to the Corporations Act.

In an insolvency scenario a transaction may also be capable of being attacked because it is an unfair preference, an uncommercial transaction or an unreasonable director-related transaction.

If you would like more information about these issues, please contact Graham Roberts on +61 7 3231 2404 or David Grace on +61 7 3231 2421.