Trouble in paradise

Are shareholders better of relying on personal rights rather than suing directors for alleged breaches of duty, asks Prof Bob Baxt AO FAICDLife.

For many generations in Australian and English company law, shareholders (members) of companies have faced significant difficulties in seeking remedies for themselves in relation to actions on the part of the company and its directors, which allegedly impact their rights as shareholders (or members).

Until the Australian Government enacted legislation to virtually remove the operation of the famous (infamous) rule in Foss v Harbottle [1843] 67 ER 189, it was almost impossible for shareholders to bring such an action in the name of the company. In the frst decade of this century, the federal government enacted legislation that made it a lot easier for shareholders to bring such action by introducing the new statutory representative action — to be used together with relying on sections 232 and 233 of the Corporations Act [2001] (Cth). It’s fair to say that since its enactment, shareholders have found it much easier to bring action against the directors of a company to protect their personal rights. The relief they can obtain ranges from damages to reflect the loss they have suffered from the alleged wrongdoing, to an order (although reluctantly on the part of the courts) winding up the company in extreme cases.

However, there are situations where the complaint being made by shareholders against directors or the company reflects not just a personal complaint that their rights as individual shareholders are being affected by the actions of other shareholders (who are also directors or who may be partners of directors), but also affects the rights of directors to run the company in what they believe to be the best way possible for the company.

Courts reluctant to interefere with decision-making of directors in performance of duties

In company law in Australia, the UK, and other common law jurisdictions, courts have generally been reluctant to interfere with the decision-making of directors in performing their duties as directors of the company. It is rare that the court will second-guess the choices of directors in taking significant decisions concerning the relevant company, investment of its assets and furtherance of its objectives.

Directors are obliged under both common law and the Corporations Act to act in good faith and in the best interests of the company, and they have strong positive duties imposed on them by the legislation not to act without proper attention to the care and diligence they are expected to exercise.

For many years, courts were reluctant to rule against directors, even on the grounds of alleged breaches of duty of care and negligence.

But since 1925 with the case of Re City Equitable Fire Insurance Co [1925] Ch 407, there has been a greater willingness on the part of the courts to rule against directors for alleged breaches of duty. Despite this change in direction, actions relying on breaches of duty of care and diligence rarely succeeded. However, the High Court of Australia made a watershed decision in the litigation surrounding James Hardie in relation to its asbestos mining and related activities. In ASIC v Hellicar [2012] HCA 17, the High Court held that the directors of the company had failed to properly assess the various risks involved in relation to the reconstruction and organisation of the relevant company, and the removal of certain rights of workers in the company, for claims arising out of alleged negligence. As a result, the directors had breached their duty of care and diligence. The case has caused considerable discussion and debate in the Australian community, but it is generally regarded as the benchmark in dealing with cases relating to duties of care and diligence.

However, in the context of cases where directors are faced with questions of whether they should accept particular takeover offers or arrangements that might result in the reconstruction of the company’s affairs (especially if the rearrangement and reconstruction lead to cross holdings between the directors of the relevant company and the company with which the new schemes are to operate), the courts are more than reluctant in second guessing the directors’ decision. Usually, the courts will not anticipate the decisions of directors to approve a particular scheme, especially if that scheme or a similar arrangement has been the subject of shareholder meetings and has been approved in general principle by the courts.

In the recent decision of RBC Investor Services Australia Nominees Pty Limited v Brickworks Limited [2017] FCA 756, Justice Jagot had the very difficult task of determining whether a claim for oppression brought by shareholders — dissatisfied with the decision to go ahead with the reconstruction and rearrangement — amounted to oppression pursuant to sections 232 and 233 of the Act. Justice Jagot ruled that despite a strong case being made by the complainants that their rights had been affected in a way not to their liking, and was indeed slightly harmful to their interests, the decisions of the directors to pursue the relevant reconstruction and rearrangement should be allowed to proceed.

Her language in dismissing the claim and upholding the decision of the directors in relation to this arrangement is telling, and will no doubt be influential in future cases in which a similar set of facts involving reconstructions arise. In the words of Justice Jagot at paragraph 42: “the role of the court is not to step into the shoes of the directors and unilaterally decide what it thinks to be in the best interests of the company as a whole.

The courts recognise that it is the responsibility of the directors to weigh the competing considerations with which they will be routinely confronted and determine what is in the best interests of the company as a whole.”

This simply contrasted to the decision, in different yet significant circumstances, of Justice Sifris in Exton v Exton Pty Limited [2017] 118 ACSR 411, providing a unique illustration of the way in which courts will typically assess allegations of oppression. In this case, the judge ruled that the conduct, which involved misappropriation of funds, triggered an action under section 232 of the Act. In deciding whether the conduct was oppressive, Justice Sifris ruled that the essential question before him was whether the conduct involved “commercial unfairness judged objectively”, which usually resulted in harm of some sort being committed against a member. His Honour noted at paragraph 58 that the relevant conduct in this case “clearly (represented) a breach of fiduciary and statutory duty on the part of (the defendant). It ignored the corporate form. It ignored the fact that [the relevant organisation] was entitled to (the funds)” and as a result it was not in the best interests of the organisation as a whole.

In light of these differing situations, the courts have shown that while Australia does allow for remedies against oppressive conduct, where there is a clash between the interests of the minority shareholders and decisions that directors have made in identifying the bests interests of the company, courts will be reluctant to interfere. In contrast, where the rights of shareholders vis-à-vis shareholders are questioned and the impugned conduct does not interfere with the day-to-day decision-making of the organisation, such as the conduct in Exton, courts will be more willing to grant relief. This said, there have been a number of recent cases in which the courts have been quite generous in the interpretation of the oppression remedy. It is perhaps time for a further case to be argued before the highest court in the land on the reach of the oppression remedy in situations where decision-making involves not simply the rights of shareholders vis-à-vis shareholders, but also the impact that the particular decision has on the affairs of the company as a whole.