Can a third party be made to account for a breach of director’s duties?

It is an unfortunate reality that some directors of companies of all sizes engage in conduct that breaches their legal responsibilities.  In circumstances where a Court finds that the conduct of the director breached the standard of care that they owed, the Court has the power to award damages.  What happens, however, where a third party has received a benefit (knowingly or unknowingly) as a result of the director’s breach – can that third party be held accountable?

Directors’ duties

Directors are bound to provide their services to their company by upholding duties set out in the Corporations Act 2001 (Cth) (Act) and their fiduciary duties at common law.  Any breach of a directors’ duty may mean that the company could hold the director to account pursuant to the Act, the common law, or both.

Similarly, third parties who receive a benefit from a director’s breach of the duties may be held to account under the Act and the common law.

Accessory liability under the Corporations Act

Sections 180 to 183 of the Act each proscribe duties that directors must comply with in the execution of their duties.  Each of these sections, however, also imparts duties on other persons (which can include a company) who are involved with the contravention of these sections.

Section 79(c) of the Act provides that a person will be deemed to have been involved in a contravention if the person has been in any way knowingly concerned in, or party to, the contravention – whether by act or omission or directly or indirectly.

The combination of sections 180 to 183 and section 79 will impute liability on a third party who assists or is in some manner concerned with the director’s breach of their duty.

Case example

Gerard Cassegrain & Co Pty Ltd (in liquidation) v Cassegrain [2013] NSWCA 455 (Gerard’s Case)

In 2004, two directors of the appellant company loaned the sum of $194,249 from a third party who was also a family member, Felicity Cassegrain (Felicity).  In repayment of the loan, Felicity received shares held by the appellant company in two other companies.  The appellant company alleged that the shares were transferred at an undervalue.  Accordingly, it was alleged that the two directors had breached their directors’ duties and fiduciary duties, and that Felicity had been in knowing receipt of monies the subject of such breaches.  At trial the primary judge made a declaration and order that the two directors and Felicity were jointly and severally liable to compensate the appellant company for any loss to the appellant arising from the transfer of the shares to Felicity.

On Appeal, Felicity was successful in overturning the order relating to her being joint and severally liable to compensate the appellant company; not due to her not knowingly receiving the benefit, but rather for a deficient pleading not seeking appropriate relief.

Emmett JA said at [69]:

“If the allegations made in the Statement of Claim were established, it would follow, although it has never been pleaded expressly, that Felicity contravened the provisions of s 181 and s 182 of the Corporations Act, insofar as she was knowingly involved in Claude and Anthony’s contraventions…However, the absence of an express allegation that by reason of her knowing involvement Felicity was herself a contravener, coupled with the absence of any prayer for an order for compensation under s 1317H(1) against her, indicate that no claim was being made against Felicity beyond the prayers that the Transfers be set aside.”

What tests will the Courts use to determine whether a party has knowledge of the contravention

In Baden Delvaux& Lecuit v Societe Generale pour Favoriser le Development du Commerce [1992] 4 All ER 161, Gibson J at 235 identified the following five (5) categories of knowledge:

• actual knowledge;
• willfully shutting one’s eyes to the obvious;
• willfully and recklessly failing to make such inquiries as an honest and reasonable person would make;
• knowledge of circumstances which would indicate the facts to an honest and reasonable person; and
• knowledge of circumstances which would put a reasonable person on inquiry.

As Nourse LJ observed in Bank of Credit & Commerce International (Overseas) Ltd v Akindele [2001] Ch 437 at 454, the first three (3) categories have been taken to constitute actual knowledge (or its equivalent) and the last two (2) constructive knowledge.  The view in Australia is that any of the categories (1) through to (4), but not including (5), are sufficient for this purpose: The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) (2008) WASC 239 at [4748] per Owen J.

In Gerard’s Case Felicity acknowledged in cross examination that the transfer of shares was to prevent a provisional liquidator being appointed and seeking control of the shares.  Therefore this would have been held to be actual knowledge.

Case example

MG Corrosion Consultants Pty Ltd v Gilmour [2014] FCA 990

This case looked at the how knowledge of a corporate entity may be determined.

Mr Gilmour (Gilmour) was a shareholder and director of two companies; SolaKleen Pty Ltd (SolaKleen) and MG Corrosion Consultants Pty Ltd (MGCC).  The initial dispute revolved around a former director and current shareholder of MGCC, Mr Vinciguerra (Vinciguerra), bringing a derivative action on behalf of MGCC against SolaKleen and Gilmour.  The essence of the claim by MGCC (effectively Vinciguerra) was that Gilmour had breached his duty as a director under the Act and as a fiduciary under the general law by authorising payments of money by MGCC to SolaKleen that were excessive and/or unnecessary.

Given that Gilmour effectively controlled SolaKleen, his knowledge and his actions can be treated as the knowledge and actions of SolaKleen and SolaKleen was relevantly seen to have been involved in the contravention of the Act as it was complicit in the breach of the fiduciary duty owed by Gilmour to the MGCC.

What damages can a ‘knowing’ third party be liable for?

The general rule of damage is to compensate Party A for the loss suffered by them as a result of the actions of Party B.  If a transaction has occurred to the detriment of Party A, and that transaction was a breach of a directors duty owed by Party B to Party A, and Party C received a benefit knowing the transaction was a breach of Party B’s duties to Party A, then Party C may be liable for the damage incurred by Party A.

Lessons for directors

Those parties, whether individuals or corporate entities that are involved in contraventions should not think that they can escape liability.  Generally, if a director has diverted an opportunity away from a corporation, or transferred assets from a corporation, then that corporation should assess whether there is a cause of action to recover pursuant to accessory liability.

Links and further references

Legislation

ss 79(c), 180–183, 1317H Corporations Act 2001 (Cth)

Cases

Gerard Cassegrain & Co Pty Ltd (in liquidation) v Cassegrain [2013] NSWCA 4550

MG Corrosion Consultants Pty Ltd v Gilmour [2014] FCA 990

Further information about directors duties

If you need further advice on Director Duties please contact me for a confidential and obligation free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

---

Related insights about directors duties