30 April 2004
Key Points:
If a decision of the Full Court of the Supreme Court of South Australia is followed, directors of corporate trustees will be personally liable for any liability incurred by the trustee if the trustee had insufficient assets to meet that liability at the time it was incurred.
The recent South Australian Supreme Court decision on section 197 of the Corporations Act in Hanel v O'Neill [2003] SASC 409 potentially extends personal liabilityto directors of corporate trustees for debts and other liabilities that the trustee is unable to meet.
The case has particular implications for directors of large corporate trustees, directors using corporate trusts for asset protection purposes, D&O liability insurers and potentially lenders (and their agents) who take informal enforcement action.
The Corporations Act provides protection for creditors of corporate trading trusts by imposing personal liability in certain circumstances.
Before the decision, it was generally thought that directors were personally liable under the corporate trustee provision only where the corporate trustee had insufficient assets and had either committed a breach of trust or done something beyond its authority as trustee.
A majority of the Supreme Court hassuggested that directors are personally liable for the shortfall if the trustee incurs any liability that, at the time, it has insufficient assets to cover.
This is an unusual interpretation, because insolvent trading is already dealt with in separate provisions of the Corporations Act. Those provisions already impose personal liability on directors.
This case is of particular concern for directors because it potentially expands directors' personal liability in three ways.
The decision in Hanel
Firstly, there are no defences based on the director's knowledge and reasonable expectations of the trustee's financial position. Under the insolvent trading provisions, a director has a defence if he or she had reasonable grounds to expect that the company was solvent at the time of incurring the debt. The director is generally entitled to rely on information from the Chief Financial Officer or other responsible officer.
If the reasoning in this case is followed, directors of corporate trustees will have no such defence. The state of his or her knowledge and reasonable expectations of the trustee's financial position will not matter.
Secondly, the time at which the director has to be certain that the trustee has sufficient assets is the time that a liability is incurred. This again is broader and more difficult to manage that the insolvent trading provisions, which apply to directors at the time that a debt is incurred. For damages and compensation claims, liability is generally incurred at the time that the relevant incident occurs, but a debt does not become payable to the claimant until the claim is resolved by a court or settled. The difference is alarming, as it appears that if a claim is large enough to wipe out the trust fund, the directors will be personally liable for the shortfall.
Thirdly, it is asset insolvency that is in issue. The test for a director's personal liability is not the insolvent trading test of whether the company can pay its debts as they fall due, but instead whether the company has enough assets to cover the liability at the time it is incurred.
It should be noted that even though the reasoning on personal liability was of the majority judges in the decision, that position is obiter (and therefore not binding in subsequent decisions) because liability was ultimately dependent upon the corporate trustee being primarily liable. The corporate trustee's primary liability had not been established (because the Magistrate failed to consider a mitigation defence).
Overall responsibilities on directors
If followed by other courts, the decision will places onerous and potentially unmanageable responsibilities on directors of corporate trustees. There is a case for law reform on the basis of this decision.
In the absence of contrary decisions or law reform, directors should consider managing their potential liability by:
Similarly, lenders considering taking informal workout action should ensure that such action does not result in their assuming a role as a quasi-director. This could potentially attract liability.
