Was there a foreseeable risk of harm? Supreme Court of Western Australia finds directors were in breach of their statutory and common law directors’ and officers’ duties

Defendants to a proceeding related to a breach of an Asset Sale Agreement, successfully joined directors to the action by way of a third party notice, seeking damages for liability incurred where those directors had breached their directors obligations to discharge their duties with due care and diligence (Section 180(1) of the Corporations Act 2001 (Cth)).

When determining whether a director or officer has breached their duty of care and diligence, the court determined that it should have regard to the foreseeable risk of harm from the director’s actions against the potential benefits to the company.

On 6 November 2015, Reliance Online Pty Ltd (Reliance), agreed to buy the assets of the plaintiff’s insurance brokerage business, with various amounts payable on completion and in monthly instalments over a three-year period. The terms of the Asset Sale Agreement (ASA) were guaranteed by Vantage Holding Group Pty Ltd (VHG) (an operating company within the Reliance group). Relevantly, the ASA was executed by Mr Hanson on behalf of Reliance and the guarantee was executed by Mr Donnelly on behalf of VHG, directors of the respective companies, without board approval.

Prior to this date, the board of Reliance and VHG had resolved to place limitations on executive power, including the requirement for board approval to enter into any contracts, assignments, agreements, and payments above $50,000.

On 17 February 2016, the plaintiffs commenced proceedings in the Supreme Court of Victoria against Reliance and VHG for breach of the ASA, on the basis that amounts payable under the agreement had become due and payable. The plaintiffs sought to injunct VHG from disposing of the proceeds of the sale of an entity acquired after the ASA had been executed.

On 8 April 2016, Reliance joined Mr Donnelly and Mr Hanson as third parties to the proceedings on the basis that Donnelly and Hanson were officers of Reliance and VHG respectively pursuant to s 9 of the Corporations Act 2001 (Cth) (CA), and that they did not have authority to enter into the ASA and VHG guarantee and had breached common law and statutory duties they owed to Reliance and VHG to (a) exercise care and diligence; and (b) act in good faith and for a proper purpose.

On 3 November 2016, the Victorian Supreme Court ordered that the proceeding be struck out. The third-party proceedings against Mr Donnelly were then transferred to the Supreme Court of Western Australia.

This judgement is the judgement following the trial of the issues between Reliance and the third parties, Mr Donnelly and Mr Hanson.

Due Care and Diligence

The court determined that, in relation to due care and diligence to be taken, it should have regard to the foreseeable risk of harm from the director’s actions against the potential benefits to the company. The Court also looked at s 180 of the CA to determine the responsibility of the directors/officers whose conduct was at issue, having regard to the circumstance of each company.

The Court found that Mr Donnelly had failed to exercise due care and diligence on the following basis:

• He had committed Reliance to a transaction with the plaintiff, which would at best offer a marginal benefit to the company but exposed it to insolvency in the event that it could not meet its obligations under the ASA[1].
• That his actions introduced a solvency risk to VHG in circumstances where various loans owing by the defendants were in default, VHG’s business needed to be sold and VHG did not generate income of its own or have liquid assets to meet the guarantee under the ASA if called upon. It was also found that Donnelly conducted the negotiations for the purchase of the assets of another entity, ignoring a number potential problems with the business including a lack of AFS License and the fact that it was being sold by receivers and managers.

Mr Hanson was also found not to have exercised due care and diligence on the following basis:

• For the same reasons given for Donnelly, that Hanson committed Reliance to a transaction that offered marginal benefit to the company but exposed it to insolvency in the event it could not fulfil its obligations.
• That the business was being acquired from receivers of the business and was a distressed sale, and that Hanson made no inquiries to satisfy himself that the interests of Reliance were properly protected. Instead, he relied on Donnelly providing him with the broad parameters of the transaction.[2]

Failure to act in good faith and for a proper purpose

The Court held that Mr Donnelly and Mr Hanson breached their obligations under the common law directors’ and officers’ duties pursuant to s 181(1) of the CA as by entering the ASA, they failed to discharge their duties in good faith and in the best interest of Reliance or VHG, as:

• They were both aware that the board of directors had resolved that Reliance was not to undertake any asset acquisitions without the approval of the board or VHG’s shareholders.
• Mr Donnelly withheld information from Reliance and VHG until the transactions were completed as he knew the Reliance Board and VHG shareholders would not have consented to the execution of the ASA or guarantee.
• Mr Hanson committed Reliance to the ASA and Donnelly committed VHG to the Guarantee, when they knew Reliance was unable to meet its financial obligations as they fell due, most notably monetary instalments owing under the ASA.

Reliance was awarded damages in relation to interest on money held pursuant to a Court Order, Settlement sums accruing on the debt owing under the settlement sum, and legal costs. They also sought, but were not awarded, operating losses on the basis that Reliance had failed to prove such losses.

Key takeaway

While this case illustrates the results of deterioration of relationships between directors/ officers, and opportunistic acquisitions which are not in the best interests of the company, it should be noted:

• Directors are not immune from being personally joined to proceedings, where they have not acted with due care and/or failed to act in good faith.
• In relation to due care and diligence to be taken, the Court will consider the foreseeable risk of harm from the director’s actions against the potential benefits to the company.

Directors should be wary when exposing companies to insolvency in transactions, in the event that the company will not be able to fulfil obligations.

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Authored by:
Yvonne O’Byrne, Special Counsel
Freda Zacharia, Senior Associate

[1] At 212

[2] 225-231