Compensation for breaches of director’s duties

Should it be held that a director of a company has breached their statutory duties, as contained in the Corporations Act 2001 (Cth) (Act), then the question arises as to how a Court will determine the amount of compensation to be paid by the errant director.  The remedies provided for in the Act include declaratory relief, compensation orders, civil penalties, pecuniary penalties, criminal liability, disqualification and injunctive relief.  This article focuses on how the Courts have applied the law in relation to the award of compensatory damages pursuant to section 1317H of the Act.

The statutory regime relating to compensation for breach of directors’ duties

Section 1317H of the Corporations Act 2001 (Cth) (Act) relevantly provides:

“Compensation for damage suffered

(1)  A Court may order a person to compensate a corporation or registered scheme for damage suffered by the corporation or scheme if:

(a)  the person has contravened a corporation/scheme civil penalty provision in relation to the corporation or scheme; and

(b)  the damage resulted from the contravention.”

 Pursuant to subsection two (2), damage includes profits:

“(2)  In determining the damage suffered by the corporation or scheme for the purposes of making a compensation order, include profits made by any person resulting from the contravention or the offence.”

Subsection five (5) provides that a compensation order may be enforced as if it were a judgement of the Court.

How is the amount of compensation determined?

Compensation orders

Where it is established that a director has breached a section of the Act described as a civil penalty provision, section 1317H provides for the Court to make a compensation order.  The language of section 1317H is curiously drafted as the first part states for ‘damage suffered’ and the second part states ‘profits made by any person, resulting from the contravention’.  Therefore, it would seem that the section requires actual damage to result from the contravention of the statutory director’s duties in order to be the subject of a compensation order.^[1]

The way that the two (2) limbs of section 1317H are to be interpreted was considered by the Full Court of the Federal Court, comprised of JJ Finn, Stone and Perram, in Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6 (Grimaldi).  The question was whether the formula of section 1317H(2) obliges or merely empowers the Court, if it awards compensation for damage suffered, to “include profits made by any person resulting from the contravention”.^[2]  Put another way, the essence of the question was “whether the section empowered the Court to compensate for profits made from contravention without proof of a corresponding loss”.^[3]

A further explanation of the principles applicable in the determination of compensation under section 1317H are outlined in V-Flow Pty Ltd v Holyoak Industries (Vic) Pty Ltd (2013) 93 ACSR 76 (V-Flow v Holyoak) at paragraphs 53 to 74.

Withholding information, diversion of opportunity

The case of V-Flow v Holyoak involved a situation where several of Holyoak’s former officers (one director and one employee) incorporated a new company, V-Flow Pty Ltd (VFlow), which subsequently purchased the business of Variflow Melbourne Pty Ltd (Variflow).  Prior to resigning from their employment with Holyoak, three (3) officers, Brown, Matkovic and Aloe, deliberately concealed their activities from the board regarding their intentions to purchase Variflow.  They also contacted several of Holyoak’s customers as a means to secure business for VFlow to the detriment of Holyoak.

The directors of Holyoak were aware that the highly profitable Variflow was on the market in 2001 however had no idea that this was again the case in 2008.  Therefore, the conduct of the three (3) officers was to conceal information from the board and to profit from their position.  VFlow knowingly profited from this which meant it was a party to the proceeding.  It was held that this conduct amounted to a breach of sections 181, 182 and 183 of the Act.  The Primary Judge made findings under multiple heads of damages.  These heads were:

• account of profits: $1,469,178;
• equitable compensation for lost opportunity: $1,046,923;
• statutory compensation: $1,469,178; and
• damages or equitable compensation from the individual appellants of various amounts.

The amounts assessed under the respective head differed and as such Holyoak needed to make an election to receive equitable compensation or a compensation order.  The compensation order was for an account of profits, which was notably the same as the statutory compensation.  However, this is not always the case.

How was the account of profits calculated?

In calculating an account of profits, the Court adopts the nearest approximation to justice that it can make.  It is usual for the parties to adduce expert evidence based on discovery provided by the parties in relation to their gain.  It was said in V-Flow v Holyoak that:

“In principle, there is nothing wrong with the Court estimating the profit by drawing inferences, provided that there is some evidence of actual profit. The net profit before tax of V-Flow was calculated by deducting from the amount of the total value of sales made by V-Flow during the period the cost of goods sold by V-Flow, together with V-Flow’s manufacturing and other expenses, including interest and wages, during the same period.  That gave rise to a net profit before tax for the period, of $1,019,033.  That profit did not result from the contraventions of the Act by Messrs Brown, Aloe and Matkovic.”^[4]

When assessing the damage pursuant to an account of net profits the following formula was applied:^[5]

• net profits;
• plus, professional fees;
• plus, interest paid;
• less interest that would have been spent on acquiring the loan to purchase;
• less reasonable salaries that would have been paid; and
• equals the amount of the compensation order.

The above formula seeks to adjust for addbacks for expenses that would not have been incurred but for the contravention.  It also adjusts for expenses that would occur if the business was paying reasonable salaries in circumstances where no salaries were being paid.

An account of profits or damages?

An account of profits is an equitable remedy that looks to the profits that a defendant gained as a consequence of an infringement.  Alternatively, damages are concerned with the actual money lost or potential money lost as a result of a defendant’s infringing conduct.  The plaintiff must decide which remedy to pursue.  For example, on 23 February 2024, Justice Downes made the final judgement regarding the quantum (amount) of the Applicants’ loss and damage because of the Respondents’ conduct in Native Extracts Pty Ltd v Plant Extracts Pty Ltd (No 2) [2024] FCA 106.  The Court ordered that Mr Ross Macdougald and Phytoverse pay Native Extracts damages or an account of profits.  The two (2) options for compensation are as follows:

• elect $3,105,682 for lost profits due to the conduct of Plant Extracts and Ross Macdougald; or
• $1,904,375 from Mr. Ross Macdougald and Phytoverse.

The Court also ordered additional damages of $157,198 against Plant Extracts due to their flagrant copyright infringement.  Dundas Lawyers proudly acted for Native Extracts and the other applicants in these proceedings.

How is equitable compensation for lost opportunity calculated?

In V-Flow v Holyoak, the loss of opportunity involves the “anticipated profits that Holyoake would have earned had the respondents not acted as they did and instead allowed Holyoake to exploit the opportunity of acquiring Variflow’s business” (Lost Opportunity).  It was said that the equitable compensation for the Lost Opportunity was the “estimated net profit” that Holyoake would have earned from Variflow’s business between 9 April 2009 and 30 June 2011, less any adjustments as per the following formula:

• cumulative net profit $1,019,033 (for 9 April 2009 to 30 June 2011);
• add back professional fees $245,209;
• add back V-Flow interest $144,846;
• less Holyoake interest $114,544;
• add back rental expense $180,547
• add back consultant’s fees $82,084;
• add back accounting and bookkeeping $25,370;
• less Mr Matkovic’s salary $258,060;
• less Mr Aloe’s salary $277,562; and
• equals the amount of equitable compensation.

The equitable compensation for Lost Opportunity formula adds back expenses that would not have been incurred because Holyoak already had the infrastructure in place for example its operational infrastructure.  Therefore, the amount of equitable compensation was higher value than an amount of a compensation order.

Principles behind equitable compensation

Equitable compensation is an award of compensation granted by way of restitution for breach of fiduciary or other obligations owed to a plaintiff in equity.  It was said by the Court in V-Flow v Holyoak that:

“the object of the equitable remedy or damages is restitution of what the victim has lost.  The question is whether the loss would have occurred but for the breach”.^[6]

The Full Court in Grimaldi said that the “fiduciary’s liability to account to the beneficiary for conflict of duty and interest and misuse of fiduciary position can take a variety of forms”.^[7]  The inference being that the remedy is not prescriptive or limited.  The principles were described in the following passages:

• Firstly subject to the test of ‘appropriateness’^[8] ‘a beneficiary holds the benefit of any property or benefit derived in on constructive trust any property or benefit derived in breach of fiduciary duty to the extent that that property or benefit remains extant or can be traced in the fiduciary’s hands’.^[9] In relation to bribes and secret commissions see Furs Ltd v Tomkies [1936] HCA 3.
• Secondly it was said that the wrongdoing fiduciary can be liable in an in personam claim to account for profits he or she derived which are attributable to the breach of fiduciary duty.^[10]
• Thirdly a defaulting fiduciary will be liable, at the beneficiary’s election, to pay equitable compensation to a beneficiary who has suffered loss thereby, the object of the remedy being to restore the beneficiary to the position in which he or she would have been had there been no breach of fiduciary duty.^[11]

Causation and the right to recover equitable compensation

The case of O’Halloran v R T Thomas & Family Pty Ltd [1998] NSWSC 596 contains a useful analysis of the principles as they relate to the liability of a fiduciary for equitable compensation:

• “Causation General: Analysis of causation depends on the purpose and scope of the rule being applied.  Issues of causation of loss arising from the breach of fiduciary obligations are to be determined in a different way from breach of common law and statutory obligations.  The analysis by the trial judge of causation for the purposes of s212 of the Corporations Law, is not determinative of the case based on breach of director’s duties.
• Causation and Equitable Compensation: The object of equitable compensation is to restore persons who have suffered loss to the position in which they would have been if there had been no breach of the equitable obligation.  A defendant is responsible for the plaintiff’s actual loss as a consequence of the breach.
• Causation and Breach of Fiduciary Duty: The power to dispose of the property of a company is a fiduciary power.  In the case of a trustee of a traditional trust, the test of causation is whether the loss would have occurred had there been no breach.”

The appellation “fiduciary” does not invoke a fixed body of rules.  The Court must identify what constitutes “an adequate or sufficient connection” between the equitable compensation claimed and the particular fiduciary duty found to be breached.  The amount of equitable compensation will be the full amount of the money’s advanced, not the losses associated with the misuse of the fund.

Can both equitable compensation and compensation orders be awarded?

It was said by the Court in V-Flow v Holyoak that:

“normally the victim of a breach of fiduciary duty must elect between the remedy of equitable compensation or damages, on the one hand, and the remedy of account of profits, on the other”.^[12]

 Subject to the general prohibition against double recovery, the question is whether liability in equity and pursuant to breach of a civil penalty order can give rise to both compensation orders and equitable compensation.  Section 185 of the Act is of some assistance in this regard as it provides that:

“Sections 180 – 184:

(a) have effect in addition to, and not in derogation of, any rule of law relating to the duty or liability of a person because of their office or employment in relation to a corporation; and

(b) do not prevent the commencement of civil proceedings for a breach of a duty or in respect of a liability referred to in paragraph (a).”

In respect of section 185, it was said by the Full Court in Grimaldi that:

“it is open to a corporation to make a claim in equity against a director or officer for an account of profits for breach of fiduciary duty and to claim profits under s 1317H against that person if the conduct in question also contravenes a civil penalty provision”.^[13]

Therefore, an errant director may be liable for contraventions of the Act and for breaches of fiduciary duties in equity and subsequently be liable to compensate the corporation for breaches of both obligations.  The remedies are not mutually exclusive but overlap and were said to be cumulative remedies.^[14]

How is the amount of profits calculated?

It was said in Grimaldi that process referred to by the appellant was:

“an inquiry to be undertaken by a referee, pursuant to s 54A of the Federal Court of Australia Act 1976 (Cth) and the then O 72A of the Federal Court Rules, to determine the amount of profits payable as prescribed in the orders”.^[15]

Interpretation of section 1317H in Grimaldi was as follows:

“We have concluded that, in respect of the “spotter’s fee”, he and Mr Barnes obtained, Mr Grimaldi is liable to account in specie for such of the 10 million Murchison shares and options (or the product of their exercise) as he continues to hold or to have under his control for his own benefit. He is likewise liable to account for all of the value of, or the profits derived from, the balance of those shares and options. Further, he is liable to pay compensation to Chameleon pursuant to s 1317H of the Corporations Act for the amount of profits he obtained resulting from his contraventions of s 181 and s 182 of the Corporations Act.  A number of additional and supplementary orders were also made which it is unnecessary to refer to here.”^[16]

Alternative remedies

It was said by Justices Emmett, Edmonds and Rares in V-Flow v Holyoak:

“that the victim of a breach of fiduciary duties must elect between the remedy of equitable compensation or damages, on the one hand, and the remedy of account of profits, on the other”.^[17]

The addition of section 1317H of the Act was said to conflate the concepts of “equitable compensation or damages on the one hand, and account of profits on the other”.  In V-Flow v Holyoak, it was accepted that statutory damages were equal to the amount to be assessed under an equitable account of profits.  Only damage that has “resulted from” the defendant’s contravention of the relevant statutory provision can be the subject of a compensation order under section 1317H, and this test is satisfied if the defendant’s acts or omissions were so connected to the damage suffered by the corporation that, as a matter of ordinary common sense and experience, they should be regarded as the cause.

Links and further references

Legislation

Corporations Act 2001 (Cth)

Regulations

Corporations Regulations 2001 (Cth)

Cases

Aboriginal and Torres Strait Islander Corporations v Matcham (No 2) (2014) 97 ACSR 41

Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1

Brickenden v London Loan & Savings Co [1934] 3 DLR 465

Chan v Zacharia [1984] HCA 36

Furs Ltd v Tomkies [1936] HCA 3

Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6; 200 FCR 296

John Alexander’s Clubs Pty Ltd v White City Tennis Club Ltd [2010] HCA 19

Native Extracts Pty Ltd v Plant Extracts Pty Ltd (No 2) [2024] FCA 106

O’Halloran v R T Thomas & Family Pty Ltd [1998] NSWSC 596

Rich v Australian Securities and Investments Commission [2004] HCA 42

V-Flow Pty Limited v Holyoak Industries (Vic) Pty Limited [2013] FCAFC 16 (20 February 2013)

Warman International Ltd v Dwyer [1995] HCA 18

Further information about directors’ duties

If you need advice on compensation for breaches of directors’ duties, contact us 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.

[1] Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1.

[2] Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6 [621].

[3] Ibid [629].

[4] V-Flow Pty Ltd v Holyoake Industries (Vic) Pty Ltd (2013) 93 ACSR 76 [58]; citing Apand Pty Limited v Kettle Chip Co Pty Limited (No 2) [1999] FCA 483; (1999) 88 FCR 568 [571].

[5] V-Flow Pty Ltd v Holyoake Industries (Vic) Pty Ltd (2013) 93 ACSR 76 [81].

[6] Ibid [53].

[7] Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6 [639].

[8] John Alexander’s Clubs Pty Ltd v White City Tennis Club Ltd [2010] HCA 19.

[9] Keech v Sandford [1726] EngR 954.

[10] Warman International Ltd v Dwyer [1995] HCA 18.

[11] O’Halloran v R T Thomas & Family Pty Ltd [1998] NSWSC 596.

[12] V-Flow Pty Ltd v Holyoake Industries (Vic) Pty Ltd (2013) 93 ACSR 76 [53].

[13] Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6 [639].

[14] Ibid.

[15] Grimaldi v Chameleon Mining (No 2) [2012] FCAFC 6 [639].

[16] Ibid [19].

[17] V-Flow Pty Ltd v Holyoake Industries (Vic) Pty Ltd (2013) 93 ACSR 76 at 53.

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