CASE NOTE: Re Akron Roads Pty Ltd (in liquidation) (No 3) [2016] VSC 657 (11 November 2016)

CASE NOTE: Re Akron Roads Pty Ltd (in liquidation) (No 3) [2016] VSC 657 (11 November 2016) Robson J – Corporations as shadow directors- preservation of insurance proceeds (s562 CA) – material nondisclosure enabling insurer to avoid liability – where settlement amount, extent of insured liability

In the insolvent trading case of Akron Roads, the High Court decided that the liquidators could join to the proceedings, the insurer of one defendant also in liquidation and another defendant facing bankruptcy.  This was permitted in the absence of a direct claim against the insurer because of the legal consequences of s 562 of the Corporations Act. It preserves insurance proceeds for the benefit of any third party whose claim is covered by the policy. In Akron Roads, with the corporate defendant being in liquidation, s562 would preserve any insurance proceeds for Akron as third party.

The High Court ruling was a process point. The Court still had to determine the substantive issues between the parties so after the High Court decision, the case went to trial before Justice Robson of the Victorian Supreme Court in April and May 2016. Judgment was delivered on 11 November 2016.

Justice Robson’s judgment is a useful reminder of the principles governing shadow directorships. It also covers material nondisclosure in insurance and what constitutes insured liability under a policy.

Shadow directors

The main allegation in the case was that a company, Crewe Sharp Pty Ltd (in liq) was a shadow director of Akron and therefore liable for that company’s losses while  trading while insolvent.

Crewe Sharp provided management consultancy services to Akron and for a number of years prior, its Mr Crewe had been a director of Akron. He was not paid personally for acting as a director and instead Crewe Sharp billed Akron for his time as management consulting services.

In addition, Crewe Sharp provided full time finance and administration assistance to Akron from 2009 to 1 February 2010 and from at least 30 November 2009 to 1 February 2010, it assisted Akron in negotiations with its bank.

Robson J applied the NSW Court of Appeal decision in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd which sets out when a company can be a shadow director of another company. In short:

• first you must identify who are the  directors; and then
•  show a pattern of behavior in which the directors do not exercise discretion or judgment; and instead
• are accustomed to act in accordance with the instructions or wishes of others.

Robson J also noted that:

• it is not necessary for the defendant’s instructions or wishes to cover the field so long as when those instructions or wishes are given, the directors act in accordance with them;
• there must be habitual compliance over a period of time;
• where someone such as a mortgagee or bank has a genuine interest in giving advice, the fact that the board tends to accept that advice or views to preserve the company “from the mortgagee’s wrath,” does not make the mortgagee or bank a shadow director but where the instructions or wishes are not in the best interests of the company, that might support the conclusion that the other party was a shadow director.

Mr Crewe was a director of Crewe Sharp so his acts would bind that company. Crewe Sharp provided Mr Crewe’s services as a director however there was no evidence that he overbore the other directors or that they acted in accordance with his wishes. Therefore despite Mr Crewe’s directorship of Crewe Sharp, that company was not a shadow director.

Further the fact that Crewe Sharp was deeply involved in the management and administration of Akron was not determinative. These functions are not those of a director.

Loss of insurance cover

On Crewe Sharp’s  professional indemnity insurance that extended to Mr Crewe, Robson J held that the claims fell within the policy despite the argument that this was not a D & O policy and that management consulting services did not generally extend to acting as a director.

However the judge then allowed the insurer to avoid liability on the basis that the fact of Crewe Sharp providing director services had not been disclosed by it  at the time of obtaining cover and that a reasonable person in Crewe Sharp’s circumstances  would have known that this fact was relevant to the insurer’s decision whether or not to accept the risk (applying ss 21 and 28 of the Insurance Contracts Act (C’lth)).

Amount of insured liability

Finally, Robson J decided that in any event, were the policy to respond, the insurer’s liability would be limited to the amount that Mr Crewe and Akron’s liquidators had agreed he should be liable to pay: $125,000.

What had happened is that to avoid bankruptcy, Mr Crewe had settled with the liquidators on the basis that judgment be entered against him for the full claimed amount of $12,992,880.05 but that he would be required to pay only $125,000 and that he would assign his interest under the policy to the policy limit of $5,000,000 to the liquidators. The judge found that this arrangement crystallized his liability in the sum of $125,000 so that was the limit of the insurer’s liability.

Implications for business

Banks & Financiers

Banks and other financiers should be careful of the nature and extent of any advice or direction they give a board.  It is clearly in the interests of a company for it to remain solvent and be able to pay its debts however depending upon the circumstances, forcing a hasty fire sale of assets may be contrary to the best interests of a company and could expose the financier to the duties and obligations of directorships.

If the company is in breach of its covenants and the financier is concerned about its exposure then the proper course may be to appoint a receiver and manager whereupon the company would have the protection of the receiver’s s 420A duties. Financiers should not assume that duties to the company can be avoided by standing in the shadows but of course an appointment may be even more prejudicial to the company!

Directors of SME’s

The directors of many SME’s don’t receive director’s fees but instead bill companies for their time acting as a director as management consulting services provided by their personal company.

Such directors and their family companies should ensure that full disclosure is made regarding their activities when insurance cover is sought. Further they may wish to be careful about charging those services to an asset rich company within their family group.

However the real question is whether the other directors are accustomed to act in accordance with their wishes. If they are then the family company could be found to be a shadow director. For example, if the family patriarch provides his director services through another family company and all the other family members on the board do what he tells them, then his company is likely to be a shadow director as well and if it holds the family’s cherished country estate then the route to that asset may be fairly clear.