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24 May 2012

Directors' liabilities reined in

by Geoff Hoffman, Sally Sheppard

In McCracken, the Queensland Court of Appeal comprehensively demolished the idea that section 1324 could be used to order a director to pay damages to a creditor of his company

Directors have dodged a bullet, thanks to a Queensland Court of Appeal decision on Friday.

Former rugby league star – and company director – Jarrod McCracken has won his appeal against a $1.5 million damages (plus interest) award (McCracken v Phoenix Constructions (Qld) Pty Ltd [2012] QCA 129).

What took this case out of the ordinary was that the damages were awarded to someone to whom Mr McCracken thought he owed no legal duties – a creditor of his company.

Mr McCracken was originally ordered to pay the damages under a little-noticed section at the back end of the Corporations Act. That decision threatened directors with the possibility of personal damages claims from creditors and even shareholders.

Section 1324 says that a court can grant an injunction to prevent a person from contravening the Act. It also says that the court can "order that person to pay damages to any other person". Although it has been a part of company law for many years, section 1324 has rarely been used in litigation, and has never been used to order directors to pay damages for breach of their duties under the Corporations Act.

In Mr McCracken's case, the trial judge found that he had breached his duties as a director, by improperly reducing its assets (and thus its ability to pay a creditor). The trial judge used section 1324 to order Mr McCracken to pay damages to that creditor.

This decision was groundbreaking, because directors have long been held to owe no duty to creditors (or shareholders, if it comes to that). The Court's original interpretation of section 1324 in Mr McCracken's case would have severely diluted the effect of that principle. Last Friday, the Queensland Court of Appeal allowed Mr McCracken's appeal. In doing so, it comprehensively demolished the idea that section 1324 could be used to order a director to pay damages to a creditor of his company, which are merely derivative of the company‘s loss.

The Court of Appeal said that there were a host of reasons why section 1324 did not operate in this way. These ranged from the wording of the provision, to legislative policy, to very practical concerns (for example, if creditors could claim damages from directors, there'd be a race among creditors to get in first, before the director was bankrupted).

Subject, of course, to the possibility of an appeal to the High Court, the Court of Appeal's decision appears to have put the section 1324 damages genie back in its lamp, encased the lamp in lead and dropped it into a very deep part of the ocean.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.