Directors need to be cautious about making remuneration payments, particularly to themselves, as shareholders can bring statutory derivative actions to recover such payments. 

The recent Cummings Engineering[1] case, which was decided by the Supreme Court of NSW on 26 March 2014, serves as a timely reminder that directors must act in the company’s best interests, even above their own interests.  The Cummings case is also important because it considered the power of shareholders, and whether directors acting honestly can be immune from personal liability. 

Ultimately, this case is important because it reinforces that directors must act in the company’s best interests and that, if they don’t, shareholders can commence statutory derivative actions against them.

Background

Cummings Engineering Holdings Pty Ltd was a sheet metalworking business in which Mr Cummings was a shareholder and managing director. The company was a family run company, with his wife as a fellow director and his 3 sisters as minority shareholders.

In 1998 the company entered into a management agreement with Mr Cummings. For many years Mr Cummings was paid in accordance with that agreement and the company functioned profitably.

However, in 2009 the company became unprofitable and Mr Cummings decided to proceed to wind up the company. Before this occurred he sent a letter to his sisters, who were the minority shareholders, informing them that he was going to cause the company to pay him $250,000. This figure was considered a remuneration payment based on the income he was expected to earn in the management agreement the company was subject to, and also based on his early termination without six months’ notice. His sisters, unhappy with this amount responded with a counter-offer of $50,000.

Ignoring this counter-offer, Mr Cumming called a meeting of the company directors on 24 November 2009, and he and his wife (as the other director) caused the company to make a payment of $250,000 to himself.

Not surprisingly, this led to his sisters commencing a shareholder derivative action against Mr Cumming (which is a court action brought by a shareholder on behalf of a company) to recover the $250,000 payment.

The decision of the Court

Although the facts of this case are reasonably straightforward, the law is quite complex. 

As a starting point, directors are generally not allowed to make payments for retirement benefits without membership approval (see section 200B of the Corporations Act 2001 (Cth)). However, this approval is not necessary if it is a genuine payment of a pension or a lump sum payment (see section 200G). This loophole is what allowed Mr Cummings to legally make the payment to himself.

The Court’s inquiry didn’t stop at whether the payment was legal.  It also considered whether the payment was in the company’s best interests, and thus whether Mr Cummings had fulfilled his fiduciary obligation to the company under section 180 of the Corporations Act. In conjunction with this question, the Court also had to consider whether it was appropriate for the company to offer Mr Cummings a “golden handshake”, being a large payment as part of a severance package. 

The court held that the payment could not be considered as being in the best interests of the company and it could not be considered as genuine “golden cufflinks” payment, especially since it could not be justified as being for the purpose of preserving goodwill, avoiding disputation, or encouraging continuing employment. This was further supported by the fact that the company was about to be wound up.

This led to another issue for the Court, which was whether Mr Cummings could avoid his liability as a director, since he acted legally, and did not require the approval of the members to make the payment (section 1318). Section 1318 of the Corporations Act states that when a director breaches his duty, although he is liable to pay compensation to the company, the court may excuse this liability if the director was acting honestly and reasonably in the circumstances.  In this case however, the Court held that Mr Cummings could not be excused from this liability as he had not acted honestly, particularly as he had ignored the disapproval expressed by the shareholders.

What this finding means for you as a director

This case highlights the primacy of the director’s obligation to act in the best interests of the company as a whole. In this case, even though Mr Cummings did not need the shareholders’ approval to make certain parachute payments, because he acted against the shareholders’ and the company’s interests, where the shareholders themselves voiced concerns about the amounts involved, he was found in breach of his duties as a director.

Jennifer Joannou