This case highlights that the fiduciary duty to avoid conflicts of interest in particular will be strictly adhered to, with questions of fairness or unfairness of the relevant transaction being irrelevant.  Directors are reminded of the need to take great care to manage potential risks when involved in transactions in which they are acting as director of more than one company.  In particular, directors should check the rules in the companies’ constitutions around conflict of interest and if there is any concern, disclose their interest and seek approval of the companies’ members.

Mr Rich and Mr West where directors of both Allco Funds Management Limited (AFML) and Record Funds Management Limited (RFML).  AFML owned units in, and was the manager of, a wholesale property fund (Fund) and RFML was the responsible entity.

In December 2006, to address a stamp duty issue, Mr Rich proposed that AFML and RFML enter into a loan agreement (Loan Agreement) under which AFML lent the same value as its units to the Fund, and RFML simultaneously used those funds to redeem AFML’s units.  This resulted in AFML’s beneficial equity interest in the Fund being converted into an unsecured 2 year loan under which the right to receive interest payments would be equal to the distributions which AFML would have received as a unit holder.  Mr Rich and Mr Rutherford executed the Agreement on behalf of AFML and Mr West and Mr Lennox executed the Agreement on behalf of RFML.

In 2007, it became evident that the conversion had had a negative impact on the performance of the Fund and the loan with the fixed repayment date had implications for the unit price.  A Deed of Amendment of the Loan Agreement (Deed of Amendment) (this time executed by Mr West and Mr Rutherford on behalf of  AMFL and by Mr Rich and Mr West on behalf of RFML) essentially removed the repayment date and made the date of the loan repayment entirely at the discretion of RFML (the borrower).

In 2008, following the collapse of the Allco group of companies, the receivers and managers of AFML commenced proceedings.   In finding that AMFL was entitled to elect to have the Loan Agreement, the Deed of Amendment and the redemption of units rescinded ab initio, Justice Hammerschlag in the Supreme Court of New South Wales held that:

  • Mr Rich and Mr West were clearly in a position of conflict with respect to the Deed of Amendment as AFML’s interests (both economic and legal) were clearly not the same as those of RFML.  In so finding, His Honour noted that the fiduciary duty to avoid conflicts of interest is so strictly adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract entered into;
  • unless the constitution otherwise provides, a contract made in breach of the conflict duty will be voidable at the option of the company unless the director makes a full disclosure of the nature of his or her interest to the members of the company who then approve it by ordinary approval;
  • while His Honour accepted that Mr Rich and Mr West believed that what they were doing was permissible, this was not enough. The test for impropriety (for the purposes of Mr Rich and Mr West’s statutory duties under section 181(1) and 181(2) of the Corporations Act 2001 (Cth) to exercise their powers and discharge their duties as directors in good faith in the best interest of AFML and for a proper purpose, and not to improperly use their use their position to gain advantage for someone else) is objective; and
  • measured objectively:
    • no reasonable person in the position of Mr Rich and Mr West could reasonably and rationally have concluded that the Deed of Amendment was in the best interests of AFML.  It was entered into to serve the purposes of the responsible entity as representing the unit holders and the bank;
    • for the same reason, committing AFML to the transaction was not for a proper purpose; and
    • AMFL’s particular economic and legal interests were at the time subordinated to, and indeed sacrificed, in favour of more general interests of the Allco group which were not co-extensive with the interests of AFML.

See the case.