Bell Group appeal: issues for directors and creditors

Monday 5 November 2012

Authors: Tim Fitzgerald and Liam McNeely

First published in NZ Lawyer, 2 November 2012.

Introduction

In the latest episode in one of Australia's most complex and lengthy commercial disputes, the Western Australia Court of Appeal recently dismissed an appeal by a syndicate of banks (the Banks) from a decision in favour of the liquidators of the Bell Group (the Group): Westpac Banking Corporation v The Bell Group Limited (in liquidation) [No 3] [2012] WASCA 157.

The case relates to the Banks' enforcement of security, guarantees and other arrangements that companies in the Group granted at a time when they were insolvent. The Court found (among other things) that the directors breached their duties by causing the companies to enter into those arrangements, and that the Banks knew about the breaches. The result is that the Banks must pay an estimated AUD$2 – 3 billion in equitable compensation, including compound interest on payments that the Banks received in 1990.

Given the high stakes, it is unsurprising that the proceedings were vigorously contested and that the extremely lengthy judgment covers many issues that will be of interest to directors and creditors In New Zealand. This note highlights just three of the issues which may be of particular interest in this jurisdiction.

Directors' duty in relation to creditors

It is well established that when a company is insolvent, or nearing insolvency, its directors must have regard to the interests of creditors as well as shareholders. The leading New Zealand cases describe this as a duty to take into account creditors' interests: see Nicholson v Permakraft (New Zealand) Ltd (in liq) [1985] 1 NZLR 242 at 250 and Sojourner v Robb [2006] 3 NZLR 808 at [103] (upheld on appeal: Sojourner v Robb [2008] 1 NZLR 751 at [25]).

Bell Group addresses the nature and extent of this duty in some detail. Of particular interest are the ways in which the majority judges formulate the duty. Lee AJA characterised it as a duty "not to prejudice" creditors. Drummond AJA concluded that:

    "...if the circumstances of the particular case are such that there is a real risk that the creditors of a company in an insolvency context would suffer significant prejudice if the directors undertook a certain course of action, that is sufficient to show that the contemplated course of action is not in the interests of the company."

His Honour considered that casting the duty in this way was part of a wider trend towards courts being more interventionist in reviewing directors' conduct.

These formulations set a more onerous test than had been adopted at first instance (where Owen J held that the duty would be breached if the only reasonable conclusion to draw, once the interests of the creditors have been taken into account, is that a contemplated transaction will be so prejudicial to creditors that it could not be in the interests of the company as a whole). It is also considerably more onerous than a duty merely to "take into account" creditors' interests. Given that this is an area in which the law of New Zealand and Australia have previously been aligned, directors of companies approaching insolvency should be aware that their duty towards creditors may be broader than they previously anticipated.

Directors' duty to act in the best interest of individual companies within a group

Directors of more than one company in a corporate group may often consider implementing transactions involving multiple group companies, or causing one company in the group to implement a transaction for the benefit of the group as a whole. In this situation, difficult issues can arise in the application of the duty to act in good faith in the best interests of the company.

It is clear that the duty applies in respect of each individual company, such that a director may not deliberately prejudice one company in order to benefit the group (except in limited circumstances, such as where they are permitted to do so by s 131 of the Companies Act 1993). The position is less clear if the director fails to consider the position of each company individually. In those circumstances, the test in Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 can apply. The Charterbridge test provides (in summary) that directors will not breach their duty by failing to consider the position of each company if an intelligent and honest person in the position of the director could, in the circumstances, reasonably have believed the transaction would benefit of each company.

The Charterbridge test has received some support in New Zealand (see for example Nicholson v Permakraft at 247-253). However, it has been criticised in recent years. The majority in Equiticorp Finance Ltd v Bank of New Zealand (1993) 32 NSWLR 50 (CA) considered the test to be too broad. They commented in obiter that directors necessarily breach their duty by failing to consider each company's separate interests, albeit that the breach may not lead to any loss if the company is no worse off for the lack of specific consideration. On the other hand, the authors of Watts, Campbell & Hare Company Law in New Zealand at 13.4.2, describe the test as "unduly stringent". They suggest the better view is that, in the absence of evidence to the contrary, it can be assumed that the directors considered each company's interests as coinciding with those of the others, and that it is legitimate for them to do so.

The judges in Bell Group each took a different approach to the Charterbridge test. Lee AJA found that the directors' breaches were so egregious that he did not need to apply the test, but said in obiter that he agreed with the criticisms of the test in Equiticorp. His view was that "a breach of a duty not to act other than in the best interests of a company arises if the failure to consider the separate interests of the company produces a result that fails to meet the best interests of that company." The other majority judge did not comment on the test. Carr AJA, who was in the minority, wrote a long and reasoned defence of the test.

This divergence of opinion casts further doubt on the continued application of the test in New Zealand. To avoid the need to rely on the test, directors would be well-advised to consider (and properly minute their consideration of) the best interests of each relevant company.

Knowing receipt

The Court held that the Banks were liable in both knowing receipt and knowing assistance (as it is still referred to in Australia). Both doctrines merit more detailed consideration than this short article allows, especially because there are differences in the way that these issues are approached in New Zealand and in Australia which mean that some of the conclusions in Bell Group should be treated with caution on this side of the Tasman.

The Court's treatment of knowing receipt is of particular interest. Knowing receipt cases typically involve payments made in breach of trust obligations. The Court in Bell Group held that the doctrine is also engaged by breaches of fiduciary duties in other contexts. Although there is limited authority on the point, this conclusion is consistent with decisions and commentary in other common law jurisdictions (including New Zealand). The Court further concluded that the duties breached by the Bell Group's directors were fiduciary duties. The result is that creditors who knowingly receive payments which were authorised by directors acting in breach of certain directors' duties may be liable in knowing receipt.

The Court also considered the degree of knowledge required to attract liability in knowing receipt. The majority held that knowledge within categories (i) – (iv) of the well-known list in Baden v Societe Generale pour Favoriser le Developpement du Commerce at de l'Industrie en France SA [1993] 1 WLR 509 would suffice. In other words, it is sufficient to create liability if the party receiving payment knows of circumstances which would indicate the facts to an honest and reasonable person is sufficient to create liability in knowing receipt. However, mere knowledge of circumstances which would put an honest and reasonable person on inquiry will not.

Although this is an unresolved question in New Zealand, Bell Group's influence on the issue may be limited because of the different approaches the New Zealand and Australia Courts have taken to knowing receipt generally. In New Zealand, some cases have expressly treated knowing receipt as a restitutionary cause of action (see for example: Powell v Thompson [1991] 1 NZLR 597). Although the point is not determined, if the restitutionary basis of knowing receipt prevails in New Zealand then it is likely that knowledge falling within any of the Baden categories may suffice. In contrast, Bell Group applied the High Court of Australia's decision in Farah Constructions Pty Ltd v Say-Dee Pty Ltd [2007] HCA 22, which expressly did not adopt a restitutionary analysis of knowing receipt. The result is that the Court's findings on the 'knowledge' aspect of knowing receipt may be of limited influence in New Zealand.

Conclusion

Bell Group is a powerful illustration of the risks that creditors face when dealing with companies in financial difficulty. The equitable compensation award (and the compound interest that entails) shows that lenders should not assume that they cannot be worse off for accepting security or payment arrangements which place them in a better position than other creditors. Directors should also understand that the scope and application of their fundamental duty to act in the best interests of the company is not necessarily settled. Practitioners in New Zealand should be aware of these risks, but also need to be aware of differences in the details between the law of New Zealand and the law in Bell Group which mean that the case's application here will not always be straightforward.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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  • Tim Fitzgerald

    Partner Auckland
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  • Litigation and dispute resolution