As noted in our recent insolvency law update, the Western Australian Court of Appeal has recently delivered its judgment (comprising over 1,000 pages) on one of Australia's longest running pieces of litigation: Westpac Banking Corporation v The Bell Group (in liq) [No 3]. While the decision is not binding in New Zealand, it covers a range of issues that directors and financiers of companies near insolvency should be aware of.
In essence, a syndicate of banks lent money to various Bell Group companies. In addition, certain of the companies issued "convertible subordinated bonds" to foreign investors. In January 1990, following restructuring negotiations, the Bell Group entered into a number of arrangements with the banks (including guarantees, mortgage debentures and subordination deeds), which had the effect of giving the banks priority to the assets of the Bell Group companies over the other creditors, including the bondholders. It was alleged that these transactions were void under statutory undue preference provisions (statutory claims), and constituted equitable fraud (as being against public policy) and knowing receipt and knowing assistance in the directors' breach of fiduciary duty by the banks.
Very much in summary, the Court of Appeal upheld the statutory claims (rendering the transactions void), found that the directors had breached their fiduciary duties and held that the claims of knowing receipt and knowing assistance were established. They did not accept the banks' argument that the intercompany loans of the proceeds of the bonds were subordinated to the banks' claims in any event, or that the companies were estopped from denying that they were. Some of the more significant legal findings are set out below.
The respondents (essentially, the liquidators of the Bell Group companies) argued that the directors were in breach of the duties to act in the best interests of the companies and to act for a proper purpose, and that these were fiduciary duties. Whether they were fiduciary duties was relevant as to whether there was a breach which could establish a claim in knowing receipt or knowing assistance against the banks.
Lee AJA and Drummond AJA held that these duties were fiduciary duties. They also commented:
- Proscriptive duties (i.e. a duty to positively do something) may be fiduciary duties if the director is required to take a positive action to properly fulfil their fiduciary duties
- Fiduciary duties are not limited to where questions of personal benefit or conflict arise
- Lee AJA commented that the duty to exercise care and diligence may also be a fiduciary duty to the extent that it is a breach of the fundamental reliance and trust underlying the fiduciary relationship between the director and company. This will require unreasonable conduct by the director amounting to gross or culpable negligence, and loss or detriment to the company
- Drummond AJA and Carr AJA held that the fiduciary duty to act in the best interests of the company is subjective (depending on whether the directors honestly believed that their actions were in the interests of the company), whereas Drummond AJA (Carr AJA disagreed) found that the duty to act for a proper purpose is an objective test – whether the purpose is a proper purpose is a question for the court.
On the facts, the majority held that, notwithstanding that the only alternative was liquidation, at the time of entering into the transactions the directors had an obligation to consider the interests of the creditors of each company (e.g. the bondholders and Australian tax office), and knew that entering into the transactions would materially prejudice their interests. In those circumstances, carrying on business was not an option open to them if they were to perform their fiduciary duties.
This is in contrast to Carr AJA, who found, in essence that the directors had made a commercial choice which turned out to be, at most, negligent, but they were not disloyal:
With the benefit of hindsight, the Bell directors can be seen to have made the wrong call. But, in my opinion, that does not mean they breached any fiduciary duties; they were not disloyal to any of the companies which comprised the Bell group, each of which was dependent on the survival of that group.
In other words, Carr AJA was of the view that directors could take a gamble if necessary for the company to survive without breaching their fiduciary duties, but subject to the transaction being found to be voidable if the company goes into liquidation.
However, given the majority finding, directors should consider carefully before entering into arrangements that prefer any creditor or creditors when a company is near insolvency.
Knowing receipt and knowing assistance
The majority held that the banks were liable in both knowing receipt and knowing assistance. In doing so, Drummond AJA (with whom Lee AJA concurred) clarified that:
- Knowing assistance requires that the defendant assisted a trustee or other fiduciary with knowledge of the trustee's/fiduciary's dishonest and fraudulent breach of trust or breach of fiduciary duty
- "Dishonest and fraudulent design" does not require conscious wrongdoing or personal benefit – it merely requires that the breach is more than trivial and is "too serious to be excusable because the fiduciary has acted honestly, reasonably and ought fairly to be excused"
- The knowledge requirement for both knowing receipt and knowing assistance is knowledge within any of the first four categories described in Baden, i.e. actual knowledge; wilfully shutting one's eyes to the obvious; wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make; or knowledge of circumstances which would indicate the facts to an honest and reasonable person
- Knowing receipt requires that the defendant receives "trust property", which will include a disposition of company property made by a director in breach of his or her fiduciary duties. There must be a proprietary benefit transferred (not just that a financial benefit has been obtained), but it need not be tangible.
Drummond AJA also found that the knowledge of multiple agents and employees could be aggregated to justify a finding as to the state of mind of a company even if it involves actual fraud – i.e. it is not necessary to find knowledge on the part of an identified controlling mind or minds. The test is whether the people are "involved in the one transaction". There was no need for there to be a duty to communicate the information to a central person.
The respondents argued that the transactions also constituted equitable fraud, in the sense that they were contrary to public utility, or public policy. While Lee AJA accepted that there was equitable fraud in the case of a creditor who is aware of the insolvency of a debtor and participates in dealings calculated to hold off the operation of insolvency legislation to the disadvantage of the other creditors, the other Judges disagreed. They found that there is:
no foundation for the proposition that, prior to winding up, the creditors of an insolvent company have any claim to equal treatment by the company for any purpose, whether or not a financial restructure is contemplated by the company and a particular creditor. The statutory preference provisions have displaced the old law that made voluntary preferences by a debtor in contemplation of bankruptcy void as a fraud on the bankruptcy laws.
The banks were unsuccessful on the majority of the grounds. Moreover, the Court found that the Judge had erred in calculating equitable compensation – in essence, by considering the best use that the respondents could have made of the money, rather than disgorgement of the profits obtained by the banks. Given the length of time since the events at issue (approximately 22 years), the effect on the compensation payable will be significant.