Introduction

In the recent case of Thomas & Anor v Arthur Hughes Pty Limited & Ors [2015] NSWSC 1027, an attempt by a family to use liquidation as a vehicle to access the wealth tied up in their company backfired when the liquidator succeeded in having constructive trusts in favour of the Company over property transferred prior to liquidation.

This case serves as a reminder that the nature of a corporation, being a separate legal entity, has strict compliance requirements which must be observed even in circumstances where the company is wholly controlled by a family with similarly aligned interests.

Background

Anne Lewis (Company) was incorporated in 1961. At all material times, the two shareholders of the Company were Mr Lewis and his wife Mrs Lewis. Over many years Mr Lewis, using his accounting background, assisted the Company to acquire a valuable portfolio of listed company shares as well as cash investments.

Both Mr and Mrs Lewis had wills providing for their four sons. Mr Lewis’ will provided a life estate to Mrs Lewis and after she passed away the remaining estate was to be divided between his four sons, while Mrs Lewis’ will split her estate into five shares, with one share going to each son and the remaining share being split equally between her grandchildren.

Two of the Lewis’ sons were accountants, Peter and David. At the time of the events concerning the proceedings, Mr and Mrs Lewis were both into their 80s. Peter and David were concerned to minimise the income tax liabilities that might arise on the liquidation of the Company when their parents died. They retained Mr Pape, a barrister, to provide advice on the ways of winding up a Company for the benefit of the children and grandchildren of Mr and Mrs Lewis.

Mr Pape’s advice in essence provided for five new companies to be incorporated with each company buying a parcel representing 1/5th of the shares owned by the Company. These purchases would be for market price however the Company would fund the purchase by way of unsecured interest free loans, payable on demand. Once the purchases were complete the Company would be wound up, and the Company would release the new entities from any obligations under their loans. Essentially it would be a gift to the five entities by Mr and Mrs Lewis.

The intention was then that each son owned one of the new companies and a trustee would control the fifth company for the benefit of the grandchildren. This was considered by Mr Pape as a tax effective way of distributing the Company’s assets, despite the Company incurring a capital gains tax liability of over $460,000.

Peter Lewis was of the opinion that the capital gains tax liability should not be borne by the Company, and suggested alternatives. David Lewis on the other hand considered the plan by Mr Pape to be an appropriate way to carry out the wishes of his parents as expressed in their wills, and without the agreement of his siblings or his father, he went about implementing the scheme.

The scheme involved a number of trusts. In its final form, the scheme comprised of discretionary trusts in favour of each son, and a unit trust for the benefit of each grandchild.

Arthur Hughes, a newly incorporated entity, was the trustee for all trusts. Mrs Lewis was the sole shareholder of that company and by extension had control over all of the trusts.

Over a five month period in 2012, David Lewis prepared a number of cheques for signing by Mrs Lewis to be paid to the grandchildren’s trust. The cheques represented the total of the Company’s cash, amounting to approximately $3.6 million.

On 10 February 2012 the shares and stapled securities held by the Company (valued at $7.6 million) were transferred into the four new companies for each respective son in virtually equal shares.

On 5 December 2013, Peter Lewis filed an originating process seeking an order that the Company be wound up on the just and equitable ground. An order was made on 9 April 2014 for the Company to be wound up and appointing a liquidator.

Shortly after being appointed, the liquidator, on behalf of the Company, sought a declaration that Mrs Lewis had breached her duties to the Company as director. The liquidator sought for all the newly incorporated companies, including the trustee corporation, to hold their respective assets on trust for the Company, and that those entities do all things necessary to transfer their respective assets to the Company or in the alternative, a judgment for a debt of $9,136,451.27 and interest.

Was Mrs Lewis in breach of her duties?

As a director of the Company, Mrs Lewis owed the following duties to the company:

  1. A fiduciary duty to act in the best interests of the Company and to avoid a conflict between her duty to the Company and her personal interests; and
  2. A statutory duty pursuant to s 181 of the Corporations Act 2001 (Cth) (Corporations Act) to act in good faith in the best interests of the Company and for a proper purpose.

Fiduciary Duty

The interests of the Company were the interests of the shareholders, being Mr and Mrs Lewis.

Although he remained a director, Mr Lewis was admitted to a nursing home in 2010 and there were allegations that he suffered from severe dementia. In any case, Mr Lewis did not participate in the decisions of 2012, and did not provide his informed consent as a director for those decisions.

The other director, Mr Bird, was appointed after the cash transfers but was a director at the time of the share transfers. Mr Bird was an accountant at the accounting firm where Mr Lewis previously worked and had a close professional and personal relationship with Mr Lewis. He understood his role was to carry out the wishes of Mr and Mrs Lewis as expressed in their wills.

The liquidator contended the transactions did not implement Mr Lewis’ wishes as expressed in his will, as his will provided for investments of his estate to be made having regard to the interests of Mrs Lewis as life tenant and the four sons as remainder men, whereas the succession plan involved Mrs Lewis having the power to transfer capital and income unconstrained by the terms of Mr Lewis’ will.

Objectively, the transfer of assets to the five companies were inherently disadvantageous to the Company in that the loans given to the new entities were interest free and without security. The Company, and by extension Mrs Lewis, were deprived of their income stream from interest and dividends and deprived of the prospect of future capital growth of the shares and stapled securities. The court found that ultimately the transactions did not implement Mr Lewis’ testamentary wishes, even if they were a legitimate consideration.

The court accepted the motives and intentions of all parties involved were to give effect to the substance of Mr Lewis’ wishes, and that there was no dishonesty on their part. However, Mrs Lewis had breached the fiduciary duties she owed to the Company as a director. The transactions she had entered into were not for the benefit of the Company. The effect of the transactions was to transfer all of the Company’s assets to five other companies which she controlled. She obtained for herself the power to transfer both capital and income, including to herself to the exclusion of any of her children. As there was no informed consent from Mr Lewis, Mrs Lewis had breached her fiduciary duty by arranging for the transfers.

Statutory duties

Mrs Lewis was also found to have breached her statutory duty under the Corporations Act to exercise her powers in good faith in the best interests of the corporation and for a proper purpose.

The court held that the first limb, to act in good faith in the company’s best interests was subjective and would be complied with if the director honestly believed they acted in the company’s best interests. The court was unsure whether Mrs Lewis had an honest belief that she was acting in the Company’s best interests, however found that the second limb, ‘for a proper purpose’, was an objective test and for the reasons discussed above, found the transactions were not for a proper purpose.

Knowingly procuring a breach

Although David Lewis was not a director of the Company, he had knowingly procured Mrs Lewis’ breach of fiduciary duty and as a result was liable to pay equitable compensation to the Company for any loss they suffered. It was irrelevant that there was no finding of dishonesty.

The five entities which received the Company’s property by virtue of Mrs Lewis, had also done so with actual knowledge of all relevant circumstances and were found to have a personal liability to account for profits or pay compensation for any loss suffered by the Company.

Decision

The court firstly rescinded the cash payments made to the grandchildren’s company and ordered the money to be held on constructive trust for the Company and for it to be returned, along with any interest gained, less any liabilities incurred.

The security transfers to the son’s companies were rescinded and held on constructive trust for the Company. Those companies were ordered to take all steps required to transfer back the securities obtained as well as any dividends and interest received from those securities.

Finally, the court gave the Company liberty to apply for the assessment of equitable contribution that might be payable to it by the sons' companies, and personally by David Lewis and Mrs Lewis for knowingly receiving the property in breach of a fiduciary duty.

Comment

Company directors and their insurers should be mindful of the strict regulatory scheme which corporations operate within. This case provides an illustration where a number of parties have breached corporations laws despite undertaking their actions with arguably good intentions, no intentional harm to any third parties and with what they perceived to be adequate authority.