Court finds statutory duties breached by de facto director - Insolvency/Bankruptcy

This week's TGIF examines a recent NSW Supreme Court decision that illustrates the circumstances in which a person will be regarded as a 'de facto director' and the duties owed to creditors when facing insolvency.

Key takeaways

Whether a person is a 'de facto director' is a question of fact and requires consideration of the powers exercised by that person and the perception of third parties who deal with the company.
The duties of a director to act in good faith and for proper purpose may, in times of financial stress, extend to taking into account the interests of a company's creditors.
A failure to respond to notices for production and engage in public examinations may risk adverse inferences being drawn in later proceedings on such matters.

What happened?

Hemisphere Technologies Pty Ltd (the Company) was in the business of distributing antivirus and cyber security software. A distribution agreement with Kaspersky Lab UK Ltd (Kaspersky) accounted for a significant part of the Company's revenue.

On 25 August 2016, Kaspersky terminated the agreement due to unpaid royalties claimed to be owing under the distribution agreement and later commenced proceedings to recover the debt owed to it. On 22 December 2016, the Company sold its trade debtors and stock to Hemisphere Technologies AUS Pty Ltd and appointed liquidators on 17 January 2017.

On 29 June 2018, the Supreme Court of NSW appointed a special purpose liquidator (SPL) to investigate whether the director of the Company had breached his duties and, if so, pursuing any claim that may be available.

Following public examinations pursuant to Part 5.9 of the Corporations Act 2001 (Cth) (the Act), the SPL commenced proceedings against the former director of the Company and contended, despite a resignation dated 14 October 2014, that he remained a director until the winding up of the Company in 2017.

Two corporate entities were also added as defendants to the claim and orders sought against them for alleged unreasonable director-related transactions.

The Evidence

The evidence adduced at the hearing revealed that:

the director had authorised the Company to make payments as a deposit for a property to be purchased by two separate entities of which he was also a director and beneficiary under the relevant trusts; and
payments totalling $1.7 million had been made by the Company to companies of which the director was also a director and shareholder, in circumstances where the Company had ceased operating, was defending the proceedings by Kaspersky and owed a substantial debt to the ATO.

No documents were produced in earlier public examinations to explain the use of the Company's funds for such purposes and the SPL tendered transcripts of those examinations in which the director failed to provide a persuasive explanation to support the payments.

Determination

The Court ultimately concluded that the director had continued to act as director from his 'resignation' until the date of the Company's winding up and, subsequent to that finding, that his statutory duties had been breached and that the payments made in the months preceding the liquidation were voidable.

In reaching this decision, her Honour observed that:

the director's conduct, together with admissions in his examination, supported a conclusion that he met the definition of 'director' in the Act (despite his earlier resignation). That conduct included signing resolutions as a director, executing a lease as a director and deposing as such in an affidavit in the Kaspersky proceedings. In light of this, her Honour concluded that he acted as a 'de facto' director during the relevant period;
given the Company's financial circumstances, the director's statutory duties included an obligation to take into account the interests of creditors. Her Honour found that, on the evidence, the $1.7 million appeared to have been paid to entities who provided no services to the Company and to which the Company had no pre-existing liability. Moreover, her Honour noted the vague, speculative answers the director gave during his public examination and inferred that no indebtedness of the Company was required to be discharged; and
there was no evidence that the Company benefitted, either directly or indirectly, from the payments made as deposit for a property. Her Honour determined that the funds benefitted the recipients of the monies who acquired the properties (of which the director was also director and beneficiary of the underlying trusts) and the requirements for an unreasonable director-related transaction were satisfied.

As a consequence of the findings above, orders were made which required the payment of compensation by the director to the Company of $1.7 million and for the deposit amount to be repaid by the recipients.

Comment

This case serves as a useful reminder to insolvency practitioners and their advisers of the potential for claims against persons who, although no longer recorded as a director, discharge the duties attaching to the office. If the evidentiary threshold can be satisfied, claims for relief for breach of duty can be available.

The decision also demonstrates the risks of failing to respond to orders for production and meaningfully engage with questions under public examination. Such actions may lead to adverse inferences being drawn in subsequent proceedings on matters that may have a cogent explanation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.