Criminalisation of directors’ duties – the final outcome

Thursday 19 June 2014

Author: Jesse Wilson

​​Two new ​criminal offences under the Companies Act 1993 are expected to be in force soon for directors who knowingly cause their companies serious loss by acting in bad faith towards it or who dishonestly allow an insolvent company to incur debts.

The offences are being introduced though the Companies Amendment Bill (No. 4), which passed the committee of the whole House of Representatives yesterday and is expected to pass its final reading with cross-party support next week.

The passage of the legislation has been held up for over 18 months due to concerns that the proposed criminalisation measures may have a “chilling effect on legitimate business risk-taking” by directors and the associated work by officials to modify the drafting to accommodate such concerns.

This update summarises the new offences, explains how they have been pared back to protect the honest exercise of directors’ business judgement, and considers their implications.

Background to reforms

The global financial crisis prompted a detailed examination of New Zealand’s company and securities laws.  Those reviews led to a suite of changes to the regulation of financial markets in New Zealand, including the Financial Markets Authority Act 2011 and, most importantly, the Financial Markets Conduct Act 2013.

The proposals that emerged from the Ministry of Economic Development’s Review of Securities Law in June 2010 included allowing public regulators to enforce directors’ civil duties and creating criminal offences for breaches of directors’ duties.  Public enforcement of directors’ duties is now possible for public issuers under the Financial Markets Authority’s new statutory powers.  In early 2011 the Government decided it would create new criminal offences for directors of both private and public companies.  The offences would target intentional breaches of directors’ civil duties to act in good faith and in the best interests of the company (section 131 of the Companies Act 1993), to avoid carrying on the business of the company in a manner likely to create a substantial risk of serious loss to creditors (section 135), and to not allow the company to incur an obligation unless the director reasonably believes that the company can perform the obligation.

Although the Cabinet proposals encountered scepticism and opposition by academics1 and lawyers, the Government proceeded with the proposals under the Companies and Limited Partnerships Amendment Bill, which was introduced in October 2011.  As introduced, the offences would have created criminal liability for a director who breached:

  • section 131 (relating to the duty to act in the best interests of the company) knowing that the conduct was seriously detrimental to the interests of the company; or
  • section 135 (relating to reckless trading) knowing that the conduct will result in serious loss to the company’s creditors.

Those proposals encountered significant resistance from the Law Society, commercial firms such as Bell Gully, leading academics, and market participants, who expressed concern that the proposals were overreaching and unnecessary.

The Select Committee indicated it would support further consideration of the drafting of the new offences to "ensure that the provisions are expressed in a way that provides clear guidance to directors and does not have a chilling effect on legitimate business risk-taking."2 The proposals have since been pared back by successive supplementary order papers in November 2013 and June 2014.

New offences

The new Companies Amendment Bill (No 4), which was previously part of the Companies and Limited Partnerships Amendment Bill 2011, will amend the Companies Act to create two new criminal offences:3

  • Offence for serious breach of a director’s duty to act in good faith and in the best interests of the company

It will be an offence for a director to exercise powers or perform duties in bad faith towards the company, believing that such conduct is not in the best interests of the company, and knowing that the conduct will cause serious loss to the company.4 This will be a new standalone offence under section 138A of the Companies Act.

  • Offence for dishonestly allowing an insolvent company to incur debts

It will be an offence for a director to dishonestly fail to prevent the company from incurring a debt when the director knows that the company is insolvent or will become insolvent by incurring the debt.  This offence will be incorporated into the existing provision for carrying on business fraudulently under section 380 of the Companies Act.

Both offences will be punishable by up to five years’ imprisonment or a fine of up to $200,000.

Commentary

Both new offences target conscious wrongdoing and contain higher mental thresholds than the civil standards on which they were initially based.  This is appropriate.  In this context, the criminal law should strike at dishonesty and, as the Select Committee recognised, provide comfort to honest directors that they will not be exposed to criminal liability for honest business judgements and risk-taking.  It is also appropriate in this context that criminal liability should be tied to the wrongful motivations for the impugned conduct (that is, the bad faith or dishonesty) rather than the seriousness of the resulting loss.

The new offence under section 138A is narrower in scope than the equivalent Australian provision in section 184 of the Corporations Act 2001 (Cth).  Under Australian law, criminal liability can be imposed for recklessness, as well as intentional dishonesty.  In this instance, it is desirable that New Zealand has cast the net less widely than Australia.  The Companies Act is intended to facilitate the social and economic benefits that follow from the taking of business risks and allowing directors a wide discretion in matters of business judgement.  Those public interests would be poorly served by an unduly punitive regime that incentivises directors (and particularly independent directors) to resign when their company faces trouble, to take disproportionately conservative action at the expense of the business, or to expend the company’s resources wastefully on unnecessary external advisers to safeguard their personal positions.  The risks of imposing unduly tough standards of criminal liability were acknowledged by the Hon. Craig Foss, Minister of Commerce, and the opposition spokesman, the Hon. David Parker, during the Parliamentary debate on the most recent supplementary order paper to the Bill on 17 and 18 June 2014.

The new offence for allowing an insolvent company to incur debts is no longer meaningfully tied to directors’ civil duties regarding continued trading.  Rather, the language of the new offence is modelled on an Australian provision: section 588G(3) of the Corporations Act 2001 (Cth).  The way in which the offence has now been framed makes it a subspecies of the rules relating to fraud on creditors.  Again, that is a welcome change due to the vagaries associated with the section 135 prohibition on reckless trading, which make it an unsuitable foundation for a criminal offence.

In relation to both new offences, the thresholds of dishonesty, bad faith, knowledge, and belief should protect honest directors.  To that extent, the Government has achieved its objective of introducing criminal offences for serious breaches of directors’ duties in a manner that should not have a chilling effect on honest directors.

It is unclear that the new offences will add much to the existing suite of laws that prohibit such serious misconduct; including, for example, carrying on business fraudulently,5 the making of false or misleading statements in documents required under the Companies Act,6 causing loss by deception,7 or theft in a special relationship.8 It is also unclear why there should be a Companies Act offence, under the new section 138A, targeting directors when other agents or fiduciaries do not face comparable criminal liability.  The need to press forward with these reforms in the face of such doubts may be best explained by the fact that traumatic economic downturns such as the global financial crisis often create political incentives to be seen to respond decisively by committing to legislative change and then following through on such commitments.9 Market participants should therefore welcome the tempered scope of the new offences, given the current political imperative to pass criminalisation measures of some kind.


1 See Professor Peter Watts, “Criminal Penalties and Professional Negligence” Company and Securities Law Bulletin (5) May 2011; and “Criminal liability for negligence in the corporate sphere - again: proposed criminalisation of breaches of certain directors' duties under the Companies Act 1993” Company & Securities Law Bulletin (1) January 2012.

2 Commerce Committee Report, 11 December 2012, page 2.

3 The Bill will also amend the scope of section 378(a), which deals with fraudulent use of a company’s property, to clarify that the prohibition extends to fraudulently using the property for the benefit of another person other than the company.

4 However there will be no criminal liability where the powers or duties are exercised in favour of holding companies or shareholders of joint venture companies under the existing carve-outs to the equivalent civil duty in section 131(2)-(4) of the Act or for making provision for the benefit of employees when the company ceases business under the existing carve-out in section 132 of the Act.

5 Section 380 of the Companies Act 1993.

6 Section 377 of the Companies Act 1993.

7 Section 240 of the Crimes Act 1961.

8 Section 220 of the Crimes Act 1961.

9 See Treasury’s analysis of political and regulatory incentives “Regulating for better legislation – what is the potential of a Regulatory Responsibility Act?” (2 February 2011), paragraph 24.​


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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  • Jesse Wilson

    Senior Associate Auckland
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  • Corporate governance and advisory
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