A legal battle in Queensland threatens to open up a new set of liabilities for company directors.
Former rugby league star – and company director – Jarrod McCracken is appealing against a $1.5 million damages (plus interest) award.
What takes this case out of the ordinary is that the damages were awarded to someone to whom the director (Mr McCracken) owed no legal duties.
The Queensland Supreme Court made the award under a little-noticed section at the back end of the Corporations Act.
Section 1324 says that a court can, on the application of ASIC or a person affected by the conduct, 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.
In McCracken's case, the Court used section 1324 to order him to pay damages to a creditor of his company for an alleged breach of duties owed by McCracken to the company as director of the company.
What makes this decision very unusual – if not unique – is that directors have long been held to owe no duty to creditors. Although directors may be held personally liable for insolvent trading, such proceedings are brought by a company liquidator (or by a creditor only with the liquidator's consent). Unsecured creditors have otherwise been held to have no interest in the company's assets and no standing to bring proceedings directly against directors regarding their management of the company. The Court's interpretation of section 1324 in Mr McCracken's case could considerably dilute the effect of that principle.
Another potential group of "beneficiaries" is shareholders. Like creditors, shareholders have traditionally been owed no duty by directors, and so have been unable to recover damages directly from directors for breach of duty.
We understand that the decision is now being appealed. Without anticipating what the Court of Appeal will say, it is likely that the Court will be asked to decide between two competing theories about section 1324.
On the one hand, there is a school of thought that the decision against Mr McCracken merely demonstrates the hitherto unrealised potential of section 1324.
Opposing this is the view (which enjoys some judicial support) that Parliament never intended the section to override longstanding limitations on the persons to whom directors owe duties.
If the original decision stands, the implications go beyond an increase in the legal liabilities of directors. Directors who are ordered to pay damages to creditors, shareholders or other third parties for breach of statutory duties owed to the company may not be covered by their company's D&O insurance. Section 199B prevents companies from paying D&O premiums to cover liabilities arising from improper use of directors' knowledge or position (sections 182 and 183) or wilful breaches of duty in relation to the company. Almost all D&O policies, therefore, expressly exclude such liabilities, to enable the company to pay the premium without the risk of the policy being invalidated by section 199C(2).
In some instances, absence of insurance may mean that the director is not worth suing. That, however, may be small compensation for the threat of extended liability to a whole new pool of claimants.