TOPIC 10: DIRECTOR DUTIES

10.1 Definition of Director:

● The definition of a director is important because:
○ Under s 128 of the CA 93, management of the company is allocated to the directors
○ It is only the directors who are subject to director duties.

● Section 127 defines the board of directors as:

○ A quorum of the company acting together; or
○ The sole director if the company has one director.

● Schedule 3 (Proceedings of the board of a company) [can be amended by the constitution]

○ A quorum is a majority of the directors - e.g. 2 out of 3 but not 2 out of 4 directors.
○ Need quorum for meeting of directors to transact business of the company as we have discussed
(particularly when talking about management of the company).

Qualification of Directors:
● Under NZ company law (s 151(3)), only natural persons can be directors of a company (at least in de jure
sense).
○ Cf Companies Act 2006 (UK) s 155(1) which provides that a company must have at least one
director who is a natural person.

● Persons other than natural persons may be deemed directors under s 126 - Clark v Libra Developments
(2007) (CA).
○ E.g. we will discuss shadow directors - a legal entity, if effectively controls the actions of the
directors and someone in accordance with whose actions the directors are accustomed to act, that
might be a parent company, could be held to be a deemed director under s 126.

● Persons that fall into the categories listed in s 151(2) are disqualified from being directors - s 151(1) refer
○ E.g. bankrupt or under 18

● Disqualified person who acts as a director is still a director for the purpose of provisions of the Act that
impose duty or obligation on the director - s 151(4).

● Also see phoenix director prohibitions in ss 386A to F.

○ We will discuss later when we talk about insolvency duties on directors. What those phoenix
company provisions deal with is situation where you have a company that has gone into
liquidation, then some of the people involved set up a new company with a similar name (eg ABC
2020 Ltd), carrying on maybe in the same line of business with the same people involved. The new
company can be considered to be a phoenix company - arisen out of the ashes of the old
liquidated company. There are certain prohibitions on directors being involved in such phoenix
companies. We will discuss those prohibitions later as indicated.

Section 151(2) (Disqualification of Directors):

The following persons are disqualified from being appointed or holding office as a director of a company:
● (a) A person who is under 18 years of age
● (b) A person who is an undischarged bankrupt
● (baa) a person who is prohibited from being a director of a company under s 299(1)(b) of the Insolvency
Act.
● (bab) a person who is prohibited from directly or indirectly being concerned, or taking part, in the
management of a company under s 299(1)(c) of the Insolvency Act 2006.
● (e) a person who is prohibited from being a director or promoter or being concerned or taking part in the
management of a company under s 382, 383, 385 or 385AA

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 ● (eaa) a person who is prohibited from being a general partner or promotor, or being concerned or taking
part in the management of, a limited partnership under section 103A, 103B, 103D, or 103E of the Limited
Partnership Act 2008.
● (ea) a person who is prohibited from being a director or promotor of or being concerned of or taking part in
the management of, an incorporated or unincorporated body under the Financial Markets Conduct Act
2013 or the Takeovers Act 1993.
● (eab) in the case of a company that is an employer, a person who is prohibited from being an officer of an
employer under sections 142M and 142N(1)(b) of the Employment Relations Act 2000.
● (eb) A person who is prohibited from 1 or more of the following under an order made, or a notice given,
under a law of a prescribed country, State, or territory outside New Zealand:
○ (i) being a director of an overseas company
○ (ii) being a promotor of an overseas company
○ (iii) being concerned or taking part in the management of an overseas company.

● (f) A person who is subject to a property order made under section 30 or section 31 of the Protection of
Personal and Property Rights Act 1988

● (g) in relation to any particular company, a person who does not comply with any qualifications for
directors contained in the constitution of the company.
● It is not uncommon for example in some company constitutions to provide that a director must hold
a certain level of shareholding in the company. So if the particular person does not actually hold
that shareholding qualification that is required to be a director of the particular company, that will
mean the person is no longer qualified.

Appointment of Directors:
● Must consent in writing - s 152

● Directors may be appointed upon registration for incorporation - s 153(1)

○ When making an application for registration of the company, you set out who the initial directors
are, and you attach the consents to act and the directors are appointed simply on registration.

● Appointment of subsequent directors is by ordinary resolution of shareholders unless the constitution

provides otherwise otherwise - s 153(2). The constitution could provide for a super majority vote or could
provide perhaps different shareholders have automatic rights to appoint nominated directors and remove
them. But the default position under s 153 is that subsequent directors are appointed by ordinary
resolution of shareholders.
○ Remember - Automatic Self-Cleansing = shareholders can’t usurp powers of management but
can change the directors by ordinary resolution. That is their remedy if the shareholders don’t like
how the directors are managing the company.

● Normally need separate votes for each vacancy (E.g for each individual appointment of a director).

Examples of alternative appointment provisions that could be in the constitution:

● Rather than having default normal rule that directors are appointed by majority vote of shareholders:
○ E.g we have got 2 major shareholders here, each has 50% of the shares in the company, we will
just simply allow each shareholder to appoint 2 directors each which they can do by notice, and
equally they could remove those directors by notice.
○ Or might simply provide in constitution that this named individual who is the founder of the
company will remain a director until he retires.

● S 154 provides a provision for the Court to appoint directors where there is not a quorum available and it is
impossible or impractical to appoint new directors under the constitution - s 154.

Definition of a Director:

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S126(1) outlines a number of subcategories of how someone can be considered to be a director. We will deal with
each in turn - (a), (b), (c) and (d).

In this Act, director in relation to a company includes -

S126(1)(a): A person occupying the position of director of the company by whatever name called
● E.g. Gilford v Horne - Mr Horne was called ‘the governor’

● s 126(1)(a) can apply to directors whether they are formally appointed or not, or are qualified for
appointment or not. The real question is whether as a MATTER OF FACT, a person is acting as a director.
○ Paape v Fahey - Mr Ruehman was acting as a director even though he had not signed consent to
act as required by s 152.
○ Clark v Libra Developments - Mr Hyslop was acting as a director even though he was no longer
qualified to be a director b/c he was bankrupt.
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Paape v Facts:
Fahey ● Mr Ruehman was involved with a company - issue was whether he was liable as a director for
(2002) not returned investor funds on 3 Feb 2000 following a void allotment of security.
● He had written a letter to shareholders as a director about a month earlier (7 Jan 2000), but was
not formally appointed until 31 Jan 2000.
● Under s 152, a person can’t be appointed as a director unless they have consented to act as a
director. Mr Ruehman had not signed a consent to act until 10 Feb, and so argued he was not a
director on 3 Feb as there was no compliance with s 152.

Held:
● Mr Ruehman was a director under s 126(1)(a) because he was occupying the position of director
- had involved himself in the direction of the company and told subscribers that he was a director.
Clearly he had acted as a director at all relevant times.
● Whether or not he had signed a consent to act in compliance with s 152 was immaterial to
whether he was acting as a director.

Clark v Facts:
Libra ● Mr Hyslop was the sole director of Libra Developments. He became bankrupt and continued to
Develop- act as a director.
ments ● The issue was whether his actions on behalf of the company following his bankrupcy were valid
(as a bankrupt is not qualified to be a director).

Held:
● HC held and CA upheld that Mr Hyslop was a director under s 126(1)(a) despite his
bankruptcy, as he was occupying the position of director.
● Thus, Mr Hyslop’s actions were valid under a combination of s 126(1)(a) [definition of director]
and s 158(b) [actions of a person as a director are valid even though a person is not qualified for
appointment.
○ “Despite his disqualification and the prohibitions statutorily imposed on him, he was still
“occupying” the position as Libra’s director. In the management of its affairs and the
operation of its business he was held out by Libra as its director. Even if such may not
apply generally, in our view it clearly applies to a company with only one director who is
disqualified after appointment because s 128(1) requires a company’s business and
affairs to be managed under the direction of its board and s 127(b) expressly defines a
sole director as the company’s board.

S 126(1) (b)(i) & (ii): Shadow Directors

In this Act, director in relation to a company includes -

S 126(1)(b): For the purpose of essentially all of the director duty sections and a number of other sections (sections
131 to 141, 145 to 149, 298, 299, 301, 318(1) (bb), 383, 385AA, 386A to 386F, and clause 3(4)(b) of Schedule 7),
a director will include:

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 ● (i) a person in accordance with whose directions or instructions a person referred to in paragraph (a) may
be accustomed to act; and
● (ii) a person in accordance with whose directions or instructions the board of the company may be
required or is accustomed to act

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● E.g. Parent company appoints BOD to subsidiary company, and that BOD of the subsidiary does whatever
the parent tells it to do - it is accustomed to acting in accordance with the directions or instructions of the
parent and so the parent would be a shadow director under s 126(1) (b)(ii).
● E.g. Joint venture company - Shareholder A and B can each appoint 1 director to the JV company. Those
directors are each accustomed to act in accordance with the directions or instructions of their appointing
shareholders, so therefore each of the appointing shareholders would be shadow directors under s
126(1)(b)(i).

***There needs to be a PATTERN of acting in accordance with the directions / instructions. If it is just a one-off and
especially if it is just a consultation - does not really look like the director is doing what the person said, just
because they said it.
● Does the person / company make suggestions as to how the business should be run?
● Do they have decisive influence over how the business is run?
● Does a director / directors follow the approach the person suggests?
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Kuwait Asia and Dairy Containers stand for the proposition that a shareholder who has appointed employees to
the board of another company, will not by that reason only be considered a deemed director of that company.
Instead, there will be a presumption that the directors will fulfill their duties as directors of the other company when
acting in tha role, and will not abdicate those duties by simply following the instructions of their employer. However,
you need to assess the situation on the facts.

Kuwait Asia Facts:

Bank EC v ● Kuwait Asia effectively had a substantial 40% shareholding in AIC that enabled it to appoint 2
National directors to the Board of AIC. Kuwait appointed 2 of its employees - House and August.
Mutual Life ● National Mutual alleged the directors of AIC had been negligent in issuing a certificate.
Nominees ● National Mutual tried to sue Kuwait, one of the arguments being that Kuwait was a deemed
(Privy director of AIC b/c the employees it had appointed to the board of AIC were accustomed to
Council) act in accordance with the directions of Kuwait, their appointing shareholder.
○ That argument FAILED.

Held:
● The normal expectation will be that directors will fulfil the duties to the company that
they are appointed as a director of
○ Here, that House & August would act in the interests of AIC and not just do whatever
their appointing shareholder Kuwait told them to do.
● Court said it was inherently unlikely that the directors House and August when acting
as directors of AIC, were accustomed to act on the directions of Kuwait.
○ It is a Q of fact of course, but the standard assumption is that directors will be doing
what they are supposed to be doing.

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Other arguments by National Mutual:

● Kuwait was VL for the breach of duty committed by its employees House & August in the
course of their employment
○ Problem was that when House & August gave the certificates, they were acting in
their capacity as directors of AIC, not employees of Kuwait.
● Kuwait owed a direct duty of care to ensure that the business of AIC was not conducted
negligently or recklessly.
○ We know from later case of James Hardie that you won’t normally owe a duty of care

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 just because you are a shareholder of the company, in relation to the affairs of that
company.
○ James Hardie at [65] set out 3 circumstances where a parent could be held to owe a
DOC, including interference with the affairs of the subsidiary.
○ Consistent with the later approach in James Hardie, the PC in Kuwait refused to
hold that Kuwait owed a DOC in relation to the affairs of AIC, just because it was a
substantial shareholder of AIC.
○ It was argued that Kuwait owed a DOC b/c it controlled the appointment of 2 directors
to AIC, but the Court said no - absent fraud / bad faith / active interference by an
appointing shareholder, just the fact that you have appointed directors to a company
should not give rise to any duty of care.

Dairy Dairy Containers was a NZ case which followed Kuwait Asia.

Containers
v NZI Bank Facts:
(1995) ● Parent company NZDB appointed some of its employees as directors of subsidiary DCL.
● The issue was whether the parent NZDB was a shadow director of its subsidiary DCL, b/c the
employees it had appointed as directors of the subsidiary were accustomed to act in
accordance with its instructions or directions.
Held:
● Consistent with the approach in Kuwait Asia, Thomas J held that NZDB was not a deemed /
shadow director of DCL here.
● The employees it had appointed as directors were not accustomed to acting in accordance
with the Dairy Board’s instructions.
○ “As employees of NZDB I do not doubt that they were accustomed to act in
accordance with their employer’s directions or instructions, but as directors of DCL
they did not as a matter of fact receive directions or instructions from the parent
company.”
■ I.e. BUT in their capacity as the directors of the subsidiary, the directors did
not as a matter of fact receive directions or instructions from the parent
company.

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that the Courts are not that ready to find that a parent company or substantial shareholder is a deemed director just
because they have appointed employees to the board of a subsidiary company.

S 126(1)(b)(iii): POWERS UNDER CONSTITUTION

A person who exercises or is entitled to exercise or control the exercise of power which apart from the constitution
of the company, would fall to be exercised by the board.

S 126(1)(c): DELEGATION
For the purposes of sections 131 - 149, 298, 299, 301, 318(1)(bb), 383, 385, 385AA, 6A to 386F, and clause 3(4)
(b) of Sch 7, a person to whom a power or duty of the board has been directly delegated by the board with that
person’s consent or acquiescence, or who exercises the power or duty with the consent or acquiescence of the
board.

Fautpito Facts:
v Bates ● Mr Moon was the sole director of company Metalsmiths Limited. He was having difficulties
with the operation of the business.
● Mr Bates was providing tax & accounting advice and suggested to Mr Moon that he appoint
him as receiver so he could sort things out. Mr Moon agreed and Mr Bates was appointed
under a letter of appointment. Mr Bates then became the sole signatory on the company’s
bank account, and was clearly exercising the powers of management that would normally
be exercised by the Board of the company.
● O’Regan J was asked to consider whether Mr Bates was a deemed director.

Arguments:
● It was certainly arguable that Mr Bates was a deemed director under s 126(1)(a) - a person
occupying the position of director by whatever name called, as he was effectively acting as
the the board under the name of receiver. However, that was not argued.
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 ● S 126(1)(b)(iii) was argued unsuccessfully - Mr Bates was not exercising the powers of the
board because of any provision in the constitution. Rather, he was exercising those powers
because he had been asked to do so by Mr Moon pursuant to the letter of appointment as
receiver. Therefore, s 126(1)(b)(iii) could not apply.

● S 126(1)(c) did apply - Mr Bates had effectively been delegated Mr Moon’s powers of the
board, and Mr Bates had willingly exercised those powers and had therefore consented to
do that.

S 126(1)(d): SHADOW SHADOW DIRECTORS

● For the purposes of sections 145 to 149, and clause 3(4)(b) of Sch 7, a person in accordance with
whose directions or instructions a person referred to in paragraphs (a) to (c) may be required or is
accustomed to act in respect of his or her duties and powers as a director.
○ I.e if you have a deemed director under one of the previous provisions in s 126, and that deemed
director in turn is accustomed to act in accordance with the directions of someone else, then that
someone else could be a deemed director.
○ Note that s 126(1)(d) does not apply for all of the director duties sections. Only some of them -
certain provisions. Just be aware of that limitation there.

Example - fact situation of Ho v Akai:

● This case concerned company of Akai Holdings
● Company called Grande Group Ltd had a management agreement in respect of which the affairs of Akai
Holdings Ltd meant the Board of Akai Holdings had to do what Grande Group Ltd told them to do.
Therefore, Grande Group Ltd was clearly a shadow director of Akai Holdings.
● The issue in the case when it got to the full Federal Court of Australia on appeal was could Mr Ho (CEO of
parent company of Grande Group) be considered to be a deemed director because Mr Ho was effectively
pulling the strings behind Grande Group Ltd, who in turn was telling the board of Akai Holdings Ltd what to
do under the management agreement.
● So Grande Group Ltd exercising their powers under the management agreement was a shadow director,
and Mr Ho pulling the strings behind Grande Group could be said to be the shadow shadow director.
● The fact situation in that case - potentially an example of how s 126(1)(d) might potentially be applied.

S 126(2) and (3):

● In addition to s 126(1), there is also s 126(2) and (3). They cover a bit of the same ground as s 126(1)(b)(3)
- if there are provisions in the constitution that give powers to shareholders that would normally be
exercised by the Board, if the shareholders exercise those powers, then they can be held to be
deemed directors under s 126(2) and (3). Just be aware of those provisions as well - cover very similar
ground to s 126(1)(b)(3).

(2) If the constitution of a company confers a power on shareholders which would otherwise fall to be
exercised by the board, any shareholder who exercises that power or who takes part in deciding whether to
exercise that power is deemed, in relation to the exercise of the power or any consideration concerning its
exercise, to be a director for the purposes of sections 131 to 138.
➔ Note that if a shareholder is a deemed director, then they can be liable to the company for breaches of
director duties, as provided for by s 97(2).

(3) If the constitution of a company requires a director or the board to exercise or refrain from exercising a
power in accordance with a decision or direction of shareholders, any shareholder who takes part in -
(a) The making of any decision that the power should or should not be exercised; or
(b) The making of any decision whether to give a direction -

As the case may be, is deemed, in relation to making any such decision, to be a director for the purposes of
sections 131 to 138.

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Banks:
● If a company is in financial distress, a bank will be concerned about getting their money back and may
require the Board to follow certain instructions - e.g. that the company sell certain assets, take certain cost
cutting measures, maintain a certain financial ratio, etc.

● In Krtolica v Westpac Banking Corp, it was argued that the Bank was a shadow director of the company
because the board had become accustomed to acting in accordance with the instructions of the bank. This
argument was rejected:
○ There was not sufficient evidence that the Bank had taken a directing or instructing role;
○ The Board had made an independent decision to comply with the demands of the Bank
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Exceptions: S 126(1A) and (4):

(1A) RECEIVERS In this Act, director, in relation to a company does not include a receiver.

(4) PROFESSIONAL SERVICES - Paragraphs (b) to (d) of ss 1 do not include a person to the extent that the
person acts only in a professional capacity.
● E.g. solicitor or accountant acting as trusted advisor to the company - the Board often following that trusted
advisor’s advice. As long as the solicitor or accountant stays within their advisory role and is not crossing
the line and managing the company, that won’t be enough to make them a deemed director.

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● Receiver:
○ Mr Bates was supposedly appointed as a receiver by Mr Moon, however the Court said the letter of
appointment that was used was not the proper way to appoint a receiver. Mr Bates was not
appointed under a specific bank document entitling appointment of a receiver. The exception in s
126(1A) only applies to properly appointed receivers. Therefore, Mr Bates could not rely on the
exception.

● Professional Services:
○ Mr Bates also tried to rely on the professional services exception, saying he was giving tax and
accounting advice.
○ The Court said that while he was just giving tax / accounting advice, he would not be considered to
be a deemed director. However, once he was appointed as so-called receiver and took over the
management of the company and the bank account, he was doing much more than just acting as
an advisor. He was stepping across the line and acting as management in a substantive way.
That does not fall within the exception in s 126(4).

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10.2 Director’s Duties:

Pre 1993 Act:

● Before the 1993 Act was passed, directors duties were almost entirely set out in case law rather than in the
Act. There was a provision in the 1955 Act dealing with reckless trading but everything else was contained
in the CL.
● There were CL duties of care that directors had to the company and there were equitable / fiduciary duties
of loyalty - duty to act in best interests of the company
● There was also a common law duty to act for a proper purpose, and there were fiduciary duties not to
usurp corporate opportunities, not to take a profit from position as a director and not to have a conflict of
interest.
● The Law Commission considered that this approach of having all of the director’s duties in the case law
rather than in the CA was not particularly satisfactory, and one of the main purposes of the CA 93 was to
make Company Law more accessible, and particularly in relation to director’s duties to make the content of
those duties better understood by putting them into the statute (ss 131 - 149)

Companies Act 1993 reform of director duties:

● Can’t contract out of duties - s 31(1)
○ Partial contrast with CL - you could contract out of the duty of care or reduce the duty of care at
CL, but the duties as now enshrined in the CA in sections 131 to 149 can’t be contracted out of.

● Section 162 provides for limits on the abilities of a company to indemnify directors against breaches of their
duty.
○ We will discuss later on.

● CL principles relating to ratification or release of directors from their breaches of duty have been preserved
by section 177(4) of the Act.
○ We will discuss in a few weeks time as well.
○ One of the important things to note about ratification is that if the company wishes to release
directors from their breach of director duty and say we won’t sue you for that, the CL provides that
release should be granted by a decision of the shareholders of the company rather than by the
directors. That is an exception to the principle that normally decisions on management issues are
the province of the BOD and that shareholders should not get involved in management decisions.
Ratification or release of breaches of director duties is ane exception to that - case law provides it
should be the shareholders who should undertake or provide such a release. This is because it
would be unseemly for the board to release themselves from their own breach.

The structure of the Companies Act section that deals with director duties includes the following provisions:
● S 131 - Director’s duty to act in Good faith and best interests of company
● S 133 - Director’s duty to act for Proper purpose
● S 134 - Director’s duty to comply with Act and constitution
● S 135 - Reckless trading
● S 136 - Insolving tradent
● S 137 - Duty of care
● S 138A - A Good faith and best interests of company
○ An offence provision rather than another specific duty.
○ So for certain particularly bad examples of breach of duty to act in the interests of the company,
that can amount to offence giving rise to potentially 5 yr jail term.

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 ○ If act in bad faith knowing actions are contrary to the interests of the company, that can amount to
an offence under that provision.
● S 139 - 144 - Self-interested transactions
○ Transactions in which director of company has interest
● S 145 - Confidential information
● S 147 - 149 - Share dealing by directors.

Is the Companies Act 1993 a Code for Director’s Duties?

● When Parliament first introduced bill - Clause 116 of Bill preserved common law. The Select Committee
removed that clause suggesting it created uncertainty.

● There is an argument that for those provisions in the Director’s Duty section of the Act that cover the same
ground as the CL, then the CL must be impliedly repealed.

● For example, the director’s duty to act in the best interests of the company under s 131 covers the same
ground as the CL or equitable fiduciary duty to act in the best interests of the company. It would not seem
to make sense to have 2 duties essentially covering the same thing sitting alongside each other. The
statutory duty must be taken to replace the CL or equitable duty to the same effect.
○ That is particularly so when s 131 has a few wrinkles or modifications to the CL duty. For example,
let’s say you have a company that is a wholly owned subsidiary. Section 131(2) allows you to put in
the constitution of that wholly owned subsidiary a provision that says the directors of the company
can act in the best interests of the parent company, even though that may not be in the best
interests of the subsidiary. That is a statutory modification of the CL duty. It would undermine that
statutory modification if the CL duty still continued notwithstanding the introduction of s 131 in
statutory format.

● Thus, there is a reasonable argument of implied repeal of CL or equitable duties, where they cover the
same ground as the duties set out in statute.

● Example of implied repeal - Vector v Transpower.

○ This was not a company case; it was a case about pricing of essential services. In that case, there
was a question as to whether a CL doctrine called doctrine of prime necessity survived. The Court
held no - because pricing of essential services was now dealt with in the Commerce Act by the
ability of the Commerce Commission to impose price control. Impliedly, the CL doctrine of prime
necessities had gone. You were covering the same ground in a statute that the CL principle had
previously covered, and it would not make sense to preserve the CL rules alongside the statutory
rules.
○ By analogy, I would say must apply in relation to director’s duties that cover the same ground as
duties like the duty to act for proper purposes, the duty to act in best interests of company, duty to
act with care and skill - CL duties no longer needed. They have been set out in a specific way in
the Companies Act - let’s just apply the statutory duties.

● What might be preserved are those director’s duties that have not been specifically addressed or
provided for in the Act.
○ The CL duty not to profit from your position as a director, not to usurp corporate opportunities that
you are aware of because you are a director of the company. Those CL or equitable duties still
remain in force, notwithstanding that most director’s duties have been enshrined in the Companies
Act. There is some case law support for that
○ Presley case - deals with a claimed breach of the duty not to usurp corporate opportunities. That
was decided under the 1993 Act, and Winkelmann J regarded it as well established that that duty
existed, there was no suggestion in that case that it was no longer able to be relied on under the
1993 Act.

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S 131 - Director’s Duty to Act in the Best Interests of the Company

Section 131(1):
Subject to this section, a director of a company, when exercising powers or performing duties, must act in
good faith and in what the director believes to be the best interests of the company.

● This is framed as a subjective duty, however will see that cases like Sojourner v Robb suggest there is an
objective overlay to it - was the transaction for fair value? If not, then it was not in the best interests of the
company.

What are the best interests of the company - what interests do you take into account?
● The cases make clear that in most circumstances, the interests of the company are equated with the
interests of the shareholders.
○ H Timber Protection v Hickson (CA): “Subject only to any duties to creditors, the directors were
free to manage the company in the interests of its sole owner” [i.e. its sole shareholder].

● Because of the basic principle that the interests of the company are identified with the shareholders as the
owners of the company, the shareholders can normally be considered to be able to release or ratify
breaches of director duties.
○ BTI 2014 LLC v Sequana SA (2019): “It is well established that the shareholders may authorise or
subsequently ratify any intra vires act or omission of the directors so as to make lawful what would
otherwise be a breach of duty on their part. This is consistent with the basic principle that the
interests of the company are identified with the interests of the shareholders as the owners of the
company.”
■ Note that the basic position changes where the company is insolvent or of doubtful
solvency. Shareholders cannot ratify / release directors from breach of s 131 in those
circumstances.

● However, where a company is insolvent or of doubtful solvency, then the interests of the company
extends to taking into account the interests of creditors - Sojourner v Robb (NZ CA).
○ The recent English CA authority of Sequana goes into those principles in more detail. Richards LJ
said in terms of the approach to the test, the interests of creditors have to be taken into account
where the company is insolvent or is likely insolvent, with likely essentially meaning probable
insolvency. His Lordship regarded that test as essentially what some courts had talked about when
they discussed “doubtful solvency”.

Possible advantages of claiming breach of s 131 as opposed to s 137 (duty of care):

● You might have thought with s 131 claim - isn’t it hard to establish that a director didn’t honestly believe
that what they were doing was in the best interests of the company. Would it not be simpler to just claim
breach of a duty of care under s 137?

Reasons why it might be worth considering a s 131 claim in some cases:

● For breach of s 131, directors may have to compensate for decisions that turn out badly even if a
reasonable person might have made the same decisions.
● If can establish breach of s 131 - onus of proving that loss would have occurred in any event lies on
director (not so where only negligence with s 137 claim - P has to prove loss)
● Breach of s 131 is breach of Fiduciary duty so 3rd parties can become implicated if they participate
○ Can potentially make claims against 3rd party for knowing receipt - e.g. received money or
property of the company, knowing that money or property was made or provided to them in breach
of fiduciary duty; or knowing assistance - 3rd party can be held liable for knowing assistance - form

10
 of constructive trust liability if they have assisted in a breach of fiduciary duty by director in certain
circumstances.
○ Won’t go into precise test for that for knowing receipt / assistance, but the general point worth
remembering is that unlike a breach of s 137 which is not a breach of fiduciary duty, s 131 is a
breach of fiduciary duty so 3rd parties who receive money or property or who assist in breach of
fiduciary duty can potentially be held liable.
● More difficult for shareholders to ratify breach of s 131 than in relation to breach of s 137
● Breach of s 131 has more fundamental consequences than breach of s 131 - underlying contract will be
voidable at equity unless other party innocent.
○ If you have breach of fiduciary duty then the contract entered into in breach of that fiduciary duty
will be voidable at equity unless that 3rd party is innocent. That is not the case if you have a breach
of a duty of care - that is not going to impunge the transaction at all.

S 131 Good Faith - What amounts to breach of s 131 duty?

● Knowingly not acting in the company’s interests (the shareholder’s interests)

● Acting in a way that is indifferent to the fact that the actions are likely to be against the company’s
interests. Recklessness is sufficient to amount to breach of s 131: Cowan de Groot Properties Ltd v
Eagle Trust pls.
○ But gross negligence is not enough for breach of s 131 (Motorworld Ltd v Turners Actions)

● Most cases of breach of s 131 involve directors acting in their own interests or those of parties with
whom they are associated. Spiteful disloyalty can be enough - Mordecai v Mordecai.
○ Mordecai - Director deliberately ran down the company to make sure there would be no value left
for ex-wife and other family members.

● Just because you as a director engage in an action that might have some benefit for yourself, is not
enough to amount to a breach of s 131, if the action is also benefiting the company. However, the director
must not place their own interests ahead of the company’s, nor the interests of friends or other parties
ahead of the company’s.
○ Hirsche v Sims: “If . . . the Defendants truly and reasonably believed at the time that what they did
was for the interest of the company, they are not chargeable with dolus malus or breach of trust,
merely because, in promoting the interest of the Company they were also promoting their
own.”

● Cooper v Debut Homes Ltd (2019) (NZ CA):

○ “The duty in s 131 is to act in “good faith”, and in what the director “believes” is the company’s best
interest. The test is subjective. While the belief cannot be based on a wholly inappropriate
appreciation of the interests of the company, these words do not require perfect business
judgment. The duty must be assessed recognising the wide discretion given to directors in matters
of business judgment. Commercial good practice is relevant in assessing good faith.”
■ This is a recent decision of NZ CA. It has been appealed to the SC - should have decision
soon.

Examples of Breach of s 131 or overseas equivalent:

Rolled Steel (1986) (English CA):

English CA case which is an example of placing yourself or your own interests AHEAD of the company. It is an
obvious fact situation which would amount to breach of s 131 duty in NZ.

Facts ● Mr Shenkman was a director of a company Rolled Steel who breached English equivalent o f s 131
duty by causing the company to give a guarantee and mortgage.
● He had a personal company Scottish Steel which owed a debt to British Steel, which he had
personally guaranteed. The company had become insolvent and Mr Shenkman was concerned about
his personal guarantee. Therefore, on behalf of Rolled Steel, the company of which he was a

11
 director, he caused Rod Steel to provide a guarantee of Scottish Steel’s debt, and a mortgage in
support of that, so as to take the heat off himself.
○ Similar to facts of Hambro v Burnard.

Held ● Mr Shenkman’s actions were in breach of his duty to act in the best interests of the company. He was
entering into the guarantee and mortgage on behalf of the company because he was trying to
protect his own personal interests and the worries about his personal liability under his own
personal guarantee, rather than doing anything that was in the interests of Rolled Steel the company
itself.

Sojourner v Robb (NZ CA) (2008):

Directors of Aeromarine 1 Mr & Mrs Robb breached s 131 duty by allowing Aeromarine 1 to sell its business for a
purchase price which was effectively at an UNDERVALUE, because no amount was allowed in the purchase price
for goodwill.

Background:
● Aeromarine 1 was a boat building company. It extended its operations into big yachts / catamarans and
came into financial difficulty in relation to 2 contracts to Sojourner and Hiscock which were not priced well
● Mr Robb tried to refocus the focus on the previous core activities going forward, but there was an ongoing
dispute with both Hiscock and Sojourner - threats of litigation.
○ The Robbs thought Aeromarine 1 would fail if they could ont get past the contracts.
● Plan carried out - sell the business of Aeromarine 1 to Aeromarine 2 for $218,000. This was enough to pay
off the existing creditors except for Sojourner and Hiscock. Aeromarine Marine 2 then carried on the former
business of Aeromarine 1 as they had acquired the right to do so (all staff went across, customers largely
the same).
● Aeromarine 1 then went into liquidation. Sojourner and Hiscock brought a claim under s 301, which allows
the liquidator or creditor or shareholder of a company that has gone into liquidation, to inquire into the
conduct of a director and obtain such an order as the Court thinks fit (essentially on behalf of the company)
○ Note - s 301 does not add a new cause of action. It is a specific procedural way that existing
breaches of duty can be enforced once a company has gone into liquidation, which could have
been enforced in any event prior to the liquidation.
○ If there is a breach of the s131 duty while the company is still alive and well (not in liquidation),
then it would be up to the company itself (the BOD) to bring a case against a former director or
director for having reached the s 131 duty and obtain damages / compensation.
■ SEE LONG NOTES pg 146 for Section 301.

Held:
● CA says that in this situation where Aeromarine 1 was in a difficult financial position, Mr and Mrs Robb
would have been fully entitled to resign as directors if they were unwilling to be associated with Aeromarine
1’s trading. As shareholders, Mr and Mrs Robb owed no obligations to anyone in relation to the company
(i.e. consistent with Salomon v Salomon - shareholders owe no obligations to anyone). They were perfectly
entitled to place it in liquidation if they chose. Likewise, as financial backers of Aeromarine 1, Mr and Mrs
Robb (and associated entities) had no legal requirement to provide it with capital. Decisions made by Mr
and Mrs Robb as shareholders or financial backers of Aeromarine 1 are not susceptible to challenge under
s 131 of the Companies Act. So a decision by them, as shareholders, to place Aeromarine 1 in liquidation
would not have been in breach of their directors’ duties. It follows that the primary complaint against Mr
and Mrs Robb must be as to the way in which they disposed of the assets of Aeromarine 1 rather
than their decision that Aeromarine 1 should stop trading.

● Whatever the commercial prospects of Aeromarine 1 prior to restructuring, it was certainly insolvent
immediately afterwards. It was common ground before us that the obligations of Mr and Mrs Robb to the
company extended to the requirement to take into account the interests of the creditors (compare
Nicholson v Permakraft).
○ I.e. duty to act in the best interests of the company takes into account the interests of creditors,
where the company is insolvent.

12
 ● The CA then refers with approval to the New World Alliance case:
○ “It is clear that the duty to take into account the interests of creditors is merely a restriction on the
right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar
to that found in cases involving fraud on the minority. Where a company is insolvent or nearing
insolvency, the creditors are to be seen as having a direct interest in the company and that
interest cannot be overridden by the shareholders”
■ i.e. in a situation where a company is insolvent, the s 131 duty extends to taking into
account interests of creditors, and the shareholders can’t release or ratify the directors
from that breach in that situation. That makes sense - if duty to act in best interests of
company is going to take into account interests other than just the shareholder’s interests,
and in an insolvent company it must takes into account creditors’ interests, then it would
not make sense that the shareholders alone could ratify or release the breach of duty.
● To the same effect is the judgment of the NSW CA in Kinsela v Russell Kinsela
Pty Ltd (1986), which in turn has been followed and applied by the English Court
of Appeal in West Mercia Safetywear Ltd v Dodd.

● Mr and Mrs Robb owed a fiduciary duty to Aeromarine 1. They could not, as shareholders, dispense
with that duty given the company’s insolvency (for the reasons given above).
○ Here, Mr and Mrs Robb were the sole shareholders. If the company had been solvent, they would
have been within their right to to ratify / release their breaches of duty, provided they did so in their
capacity as shareholders. But given the company was insolvent, that normal right for shareholders
to ratify breach of duty is lost.

● Court discusses s 141 - if company enters into an interested transaction, that can be set aside if the
transaction was not at fair value. S 141 was not directly engaged here because there was not an attempt to
avoid the contract between Aeromarine 1 and Aeromarine 2.

● However, that concept about whether the transaction was at fair value was very influential to the Court. It
proceeded on the basis that the liability of Mr and Mrs Robb under s 131 depended on whether the
sale to Aeromarine 2 was for fair value ([at 31]).
○ The Court said this is an approach consistent with s 141 and also recognises the policy
considerations which may favour the ring-fencing of losses and the associated setting up of a
phoenix company to preserve a salvageable business. But directors who propose to adopt this
course, however, should take care to ensure that the value paid by the phoenix company (here,
Aeromarine 2) is fair. This is likely to involve, at the very least, a contemporaneous
independent valuation of the assets being acquired.
○ In terms of both the process adopted and the price which is eventually fixed, directors would be
well advised to err on the side of caution as if the sale is later held to have been at an undervalue,
the liability of the directors may well exceed the discrepancy between the contract price and the fair
value.
■ This is because for breach of s 131 - not just compensatory losses may be relevant, but
also restitutionary forms of relief such as account of profits (since it is a fiduciary duty).

KEY POINT: Movement away from a subjective approach?

● This is a very interesting approach because the test as to whether a transaction has taken place at fair
value, is not really a subjective test of whether the directors believed they were acting in the best
interests of the company.
○ So you will see a bit of a move in cases like Sojourner v Robb away from a purely subjective
approach to the application of s 131.

● This approach has received a form of endorsement by the NZSC in a similar case Morganstern. In
declining leave for appeal, the SC issued a short judgment indicating a degree of support for the approach
taken by the CA cases such as Sojourner v Robb in a situation like this - the need for independent
valuation establishing fair value, otherwise directors are likely to be held liable under s 131 in
circumstances like that
13
 ○ I.e. the approach outlined by the CA in Sojourner v Robb has received a form of endorsement by
the SC in the Morganstern case.

DHC In the case of distributions, we have already discussed the case of DHC v Arnerich. Won’t go over that
Assets Ltd again at this stage. Refer back to recording where we discussed that case under distributions.
v Arnerich:
(2019)(NZ Key passages:
HC): ● “A director’s assessment of what is in the best interests of their company while subjective,
cannot be undertaken without consideration of the creditors of the company where the
company is contemplating making payments or distributions that would exhaust its
funds and extinguish any ability to pay its creditors.”

● “I find that at the time Mr Arnerich made the distributions from the proceeds of sale to interests
associated with himself, he was not acting bona fide and in good faith, as he was not
having sufficient regard to the interests of CCL as an unpaid creditor of Vaco. His
actions were conducted with disregard to CCL’s assertions as to its entitlements under the
contract, with knowledge that the Engineer’s findings regarding those entitlements were not the
product of independent judgment, and with knowledge that CCL had access to the dispute
resolution procedures available under the contract to further advance its claim.”

How far does the duty to take into account the interests of creditors extend?
Sequana ● English CA said that the trigger for when the directors should take into account the interests
(English CA) of creditors is when the directors know or should know that the company is or likely is
to become insolvent. In this context, likely means probable (i.e. probable insolvency).
○ The Court suggested this formulation was what other courts had meant when they
had referred to “doubtful solvency”.

● At [222]: “An important issue is whether, once the creditors’ interests duty is engaged, their
interests are paramount or are to be considered without being decisive.”
○ The CA said this is not an issue that arose in the case and that is was not
straightforward. It expressed no view on it, except to say that “where the directors
know or ought to know that the company is presently and actually insolvent, it
is hard to see that creditors’ interests could be another but paramount.”
■ This issue was also the subject of some discussion in the Kinsela v
Russell case.

Kinsela v ● “To some extent the degree of financial instability and the degree of risk to the creditors are
Russell inter-related.”
● “The plainer that it is the creditors’ money that is at risk, the lower may be the risk to
which the directors, regardless of the unanimous support of all of the shareholders,
can justifiably expose the company.”
● Therefore, the degree of risk or likelihood of insolvency would be relevant to the extent to
which creditors’ interests would have to be taken into account, under the approach
postulated by Sir Lawrence Street in Kinsela.
○ However, this comment was really obiter. The company in the case was clearly
insolvent, and so if you took the approach of the English CA in Sequana, in that
situations the interests of the creditors should be paramount.

!"=18*+>"Company operated funeral home business & was clearly insolvent. The directors arranged
for the company to lease its business premises to them personally, for a rental value that was far too
low / generous. The directors were getting a great deal as tenants, however the company was not
getting a good deal on the rent at all. The granting of the lease in those circumstances of insolvency,
was regarded as being a breach of the Australian equivalent of our s 131 duty to act in the best
interests of the company.

S 131 in the Context of GROUPS of Companies:

● Specific context in which s 131 can be quite tricky to apply is groups of companies. You might have a
holding company / parent with a number of subsidiaries, and actions being taken by 1 company in the
group, which might be said to support the group as a whole, but maybe not necessarily that particular
company if we are just looking at that particular transaction by itself.
14
 ● At CL - director of 1 company in a group of companies was not entitled to sacrifice the interests of the
company for which they were acting, for other companies in the group (Walker v Wimborne)
● However that CL position has been modified somewhat by some statutory provisions in section 131.

Sections 131(2) to (4):

Subsections (2) and (3) are relevant to groups of companies. Subsection (4) deals with joint ventures which we will
come back to.

● S131(2): A director of a company that is a wholly-owned subsidiary may, when exercising powers or
performing duties as a director, if expressly permitted to do so by the constitution of the company, act
in a manner which he or she believes is in the best interests of the company’s holding company
even though it may not be in the best interests of the company.
○ Wholly owned subsidiary = parent company owns 100% of the shares in the subsidiary.

● S131(3): A director of a company that is a subsidiary (but not a wholly-owned subsidiary) may, when
exercising powers or performing duties as a director, if expressly permitted to do so by the constitution
of the company and with the prior agreement of the shareholders (other than its holding company) act
in a manner which he or she believes is in the best interests of the company’s holding company even
though it may not be in the best interests of the company.
○ Not a wholly owned subsidiary = e.g. 70% or 51% subsidiary, then you need a provision in the
constitution that allows the directors to act in the best interests of the holding company AND you
need to get the prior agreement of the shareholders.

***IMPORTANT = These sections 131(2) and (3) require a wholly owned parent and subsidiary type relationship to
work. There are other forms of group that will not fall within that definition, such as in Fisk v Fawcet.

Fisk v This case highlights the risk under s 131 of operating a group of companies in a way that does not ensure
Fawcet that fair value passes between members of the group in relation to inter-group transactions.
(2013)
(NZHC) Facts:
● Involved the Globe Group which contained 5 companies, all of which were operated by Mr Fawcet
to assist each other in relation to property development projects. The funds were shifted around as
needed.
● One of the companies Luxta went into liquidation, and the liquidators of Luxta brought a claim for
breach of s 131 against Mr Fawcet in relation to some transactions entered into by Luxta.
● Luxta had sold 2 properties to another company in the group, Contorto for $857,000. It was
accepted that this was a fair market price, however the problem was that Luxta did not ensure that
Contorto paid the full price on settlement - Contorto only paid $45,000 on settlement and then the
rest of the price was left outstanding (no security was provided by Contorto). Contorto then used
the property to obtain a $500,000 advance from the bank, which was then paid onto other group
companies for use in development projects.
● The way this group of companies was set up was that Luxta was not a holding company to
Contorto or any of the others in the group. The companies in the group were essentially
brother / sister companies. The shareholding in each was the same (Mr Fawcet and related
interests), however there was not a holding / subsidiary relationship between those
companies as between themselves. Therefore, s 131(2) / (3) were never going to be
relevant.
● Mr Fawcet argued that he had not breached s 131, as he honestly believed that the transactions
were in the best interests of Luxta, as he believed that the development projects were in the
interests of all of the companies in the Group.

Held:
● That argument was rejected - Judge said you have to look at this on a company by company
basis, and focus on the parties to the transaction.
○ “In my opinion, s 131 require the Court to concentrate on the parties to the transaction (in
this case, Luxta and Contorto) in order to determine, objectively, whether the director,
whose conduct is under review, met the required standard. Arranging a transfer of
assets from one company to another company within a group without full payment
(Luxta transferred the properties to Contorto without fully payment), even if that is done in
the general expectation that other companies within the group might assist later with

15
 advances to meet debts or with a guarantee of liability to a creditor, does not meet that
standard.” (i.e. the standard under s 131).
■ Mr Fawcet was held to be in breach.

● In Fisk v Fawcet, s 131(2) or (3) could not apply because the parties to the same transaction were not in a
parent / subsidiary relationship and so no provision in the constitution that the directors could act in the
best interests of the holding company, even if that may not be in the best interests of the subsidiary.

● But one interesting point is - even if you did have a 100% holding company and 100% owned subsidiary,
and had provision in subsidiary’s constitution that allowed the directors of the subsidiary to act in the best
interests of the holding company rather than the interests of the subsidiary, would that be a complete get
out of jail free card?

● Peter Watts in the textbook says that is not necessarily the case. If you look at wording of subsections 2, 3
and 4 - the use of the word ‘may’ - you have the provision in companies constitution that says the director
can act in manner that he or she believes is in best interests of holding company even though it MAY not
be in best interests of the subsidiary. But what if it is not a case of arguably may not be in the best interests
of the subsidiary, but it is clearly not in the best interests of the subsidiary in a situation where the
particular action is positively detrimental to the interests of the subsidiary, would subsection 2 be able to be
used in that context?

S 131 in the Context of Joint Venture Companies:

● S 131(4) - A director of a company that is carrying out a joint venture between the shareholders may,
when exercising powers or performing duties as a director in connection with the carrying out of the joint
venture, if expressly permitted to do so by the constitution of the company, act in a manner which
he or she believes is in the best interests of a shareholder or shareholders, even though it may not
be in the best interests of the company.
○ E.g. shareholders in a joint venture company each want the directors they appoint to act in their
respective interests as nominating shareholders. S 131(4) says that is possible, provided that it is
made express in the constitution.

● Example: JV company - Shareholder A has 60% shareholding and so is able to appoint 3 directors (A1, A2
and A3); Shareholder B has a 40% shareholding and so is able to appoint 2 directors (B1, B2). The
constitution contains a provision that the directors of the company may act in the best interests of their
nominating shareholder, even if that is not in the interests of the joint venture company. Directors A1, A2
and A3 are able to outvote directors B1 and B2.
○ If directors A1, A2 and A3 propose to do something that is in the interests of their nominating
shareholder, but which is CLEARLY NOT in the interests of the joint venture company - it is
positively detrimental to the interests of the company, can they still rely on s 131(4) in that
circumstance?

● Shell v Todd case is an example of that - one group of directors of the joint venture company wanted to
cause the company to discontinue providing certain services which accounted for about 78% of the
revenue of the company. The other group of directors wanted to stop them from being able to agree to do
this. In that case, as it happened, there was no provision in the constitution permitted by s 131(4). So the
argument of breach was clearer in the Todd case than in a situation where you did have a provision in the
constitution which did allow the directors to act in the interests of their nominating shareholder.

● On this question, Peter Watts discusses the English case of Re Southern Counties Fresh Foods. There
is no equivalent provision to s 131(4) in England, and so the case only takes us so far. However, Watts
thought the approach taken in the case might be analogous to how the word ‘may’ in s 131(2), (3) and (4)
might be interpreted.
○ In Re Southern Counties Fresh Foods, Warren J of the English High Court was prepared to
accept that in principle, a shareholder’s agreement might modify the duty to act in the best
interests of the company. However, he doubted that shareholders agreement would sanction
decisions that were POSITIVELY DETRIMENTAL TO THE COMPANY.
16
 ● Peter Watts takes the view (and JL is sympathetic to the argument) that if you have got a proposed action
that is positively detrimental to the JV company, then maybe s 131(4) does not apply. S 131(4) says that if
permitted to do so by the constitution of the JV company, the directors may act in what they believe are the
best interests of their nominating shareholder, even though that may not be in the best interests of the
company. However, this is a situation where it clearly will not be in the best interests of the company.
Thus, Peter Watts’ argument would be that if the proposed action was positively detrimental to the
interests of the JV company, then s 131 would not save you.

● This particular point has not been addressed in the Courts yet. However, there have been some cases
which suggest that s 131(2), (3) and (4) will be looked at strictly. One such case is the CA decision in Steel
& Tube Holdings, where a provision in the constitution under s 131(2) was held not to apply.

Steel & Tube Holdings:

● Steel & Tube Holdings (parent) had a wholly owned subsidiary Stube that had an industrial lease of land
from Lewis Holdings. The company forgot to give notice not to renew, and so the lease was automatically
renewed on onerous terms for another 21 years. STH caused Stube to be put into liquidation. The lessor
Lewis Holdings sought for the court to order that STH as a related company make a contribution to the
liquidation of its subsidiary Stube. The HC ordered that STH make a contribution order to the subsidiary
company under s 271, and this was confirmed by the CA.
● One of the big factors behind that decision was that the directors of the subsidiary Stube had not treated
the company as a separate legal entity - they simply treated it as a division of the parent STH. One of the
arguments which was made in response was a provision in the constitution of Stube which said that the
directors of Stube could act in the best interests of the parent STH, even though that may not be in the best
interests of Stube.

● HOWEVER, the Court said that even where you have one of these provisions in your constitution, if
you do not separately consider the interests of the subsidiary and have separate board meetings,
then you cannot be complying with s 131(2).
○ “Messrs Calavrias and Candy (directors of Stube) did not structure their decision making in a
manner that acknowledged the separate commercial existence of Stube. They did not hold formal
board meetings for Stube or discuss Stube’s business with a conscious appreciation they were
Stube’s directors. Although they were entitled by Stube’s constitution to act in the best interests of
STH, that did not entitle the directors to ignore the separate interests of Stube or conflate them with
STH’s interests. The directors of Stube were in breach of s 131(1) thereby.”

● The strict interpretation and use of the exception in s 131(2) in Steel & Tube Holdings shows that the
Courts will not treat the exceptions in s 131(2), (3) and (4) as too readily permitting directors to avoid their
duty to act in the best interests of the company (subsidiary or JV company as the case may be).

● That seems to be consistent with the sort of argument Peter Watts would make about the use of the word
may in sections 131(2), (3) and (4), and that approach he suggests - if you act in a way that is positively
distrital to interests of particular company, that is unlikely to be good enough even if you have one
of these provisions in the constitution complying with s 131(2), (3) or (4).

Impact on Transactions - s 131:

● One of the important things about s 131 is that it is a fiduciary duty. Breach of fiduciary duty can result in
the underlying transaction being held voidable at equity, unless the 3rd party to the transaction is innocent.
○ The fact that a breach of fiduciary duty causes a transaction to be voidable is noted in a footnote in
the Autumn Tree case (footnote 3).
■ “As discussed, at the hearing, on the facts alleged by Autumn Tree, Autumn Tree would
have had the right to set aside the transaction as voidable for breach of Tina’s fiduciary
duty as a director in failing to act in the best interests of Autumn Tree.”

● If the transaction is voidable, the company can either avoid or affirm it, unless the 3rd party is innocent.

17
 ● The right to void a transaction can be lost through the passage of time or if the company has affirmed the
transaction and if the parties can’t be put back into their original position.

● Kinsela v Russell - Company operating funeral home business was clearly insolvent. The directors
caused the company to lease the business premises to them personally, at a rental value that was far too
low (not market rental). The lease was held to be a breach of the directors’ duty to act in the best interests
of the company, and was held voidable as a result and was duly avoided.
○ The case presents an unusually straightforward factual pattern. The company was plainly insolvent at
the date of the lease and its collapse on that ground was imminent; thus, no occasion arises to analyse
the degree of financial instability which may be necessary to impose upon directors the obligation to
consider the position of creditors. Secondly the prejudice to the creditors was the direct and
calculated result of the lease: its purpose was to place the company’s assets beyond the reach of the
creditors; there is thus no occasion to examine on a value basis the commercial wisdom or unwisdom of
the decision of the directors.

○ The lease was not ultra vires and void as exceeding the capacity of the company. It was, however,
entered into by the directors (albeit with unanimous approval of all of the shareholders) in breach of their
duty to the company in that it directly prejudiced the creditors of the company. It was accordingly a
voidable transaction and, no third party rights having intervened, the company on the initiation
of the liquidator is entitled to the aid of the court to avoid it.
■ b/c where company is insolvent, the duty to act in the best interests of the company includes
the interests of creditors.

,#!IJKLMGNM#OKL#PKIJGNQ#PKNMLGPM!NR#STUAM!KNA>#
You might have a company contracting problem question and be looking at it in 2 ways
● 1) Was there actual authority (removed by dishonesty?), or alternatively apparent authority for the
transaction?
● 2) Even if established that the transaction is valid as a matter of law (b/c there is actual or apparent
authority), there might be a question that nevertheless, if the transaction was entered into by breach of
fiduciary duty by the directors, the transaction might still be voidable at equity unless the third party is
innocent.

Offence Provision (S 138A) - introduced in 2014:

● S 138A is a criminal offence provision - does not give rise to any liability in damages / voidance of
transaction.

● If you have a problem question and are asked to advise a director on their personal liability for damages or
whether a transaction can be set aside for some reason, then s 138A is not relevant.

● However, if you are asked to advise the director on the potential risks to them of a proposed action, and
you think that action is clearly in breach of the director’s duty to act in the best interests of the company
under s 131, then the fact the conduct could be considered a criminal offence under s 138A would be worth
advising the director about - max penalty is 5 years in prison or a $200,000 fine.

A director of a company commits an offence if the director performs duties as a director of the company -
(a) In bad faith towards the company, believing that the conduct is not in the best interests of the company;
and
(b) Knowing that the conduct will cause serious loss to the company.

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Director’s Duties re Profiting:

These are CL or equitable duties. They are not specifically set out in the Act, except to a minor extent in s 145.

2 aspects to the duty:

18
 ● Directors must not profit from use of their position in any way, without the company’s consent.
● Directors must not pursue business opportunities having connection with the company’s business, again
unless the company consents.

,#M'+#1+"+4)5#4+<+3/#2%4#$4+)('#0*#)"#account of profits or a constructive trust over the property that has been
obtained from the breach of the duty.

Do the rules against profiting survive the passing of the 1993 Act?
● The Courts have assumed that the duties against profiting do survive - Presley v CallPlus (2008)
○ Annette Presley alleged that the other directors of CallPlus had usurped a corporate opportunity of
CallPlus for their own benefit. Winklemann J regarded the case as being seriously arguable and
gave leave for the bringing of a derivative action by Annette Presley against the other directors.
Winkelmann J assumed that the duty still existed.
■ Will discuss in shareholder remedies part of the course.

● Can sometimes plead a breach of s 131 e.g. He v Chen (CA) (2011), but only if the defendant is still a
director.
○ When a director usurps a corporate opportunity, that can be considered a breach of the s 131 duty
to act in the best interests of the company. However, the way s 131 is worded (a director
exercising their powers or performing their duties as a director in good faith and in what they
believe are the company’s best interests), you really need to be a present director for a breach of s
131 to occur. If you are no longer a director and then you go and usurp a corporate opportunity, on
JL’s view of the wording of s 131, the section no longer applies to you.

○ However, the equitable duty not to usurp a corporate opportunity has been held to apply to
situations in which directors have resigned and have then gone on to usurp their corporate
opportunity.

Duty 1: Directors must not profit from their position in any way, unless the company consents
The HL case of Regal Hastings (1942) is authority for the proposition that directors cannot profit from their position
as a director without the company’s consent.

Regal Facts:
Hastings ● Regal Hastings owned a cinema (the Regal). Their leases for 2 other cinemas were up for sale
(HL) (Elite and Deluxe). The directors of Regal Hastings decided the company should buy these 2
cinemas with a view to selling the 3 cinemas together as a group lot at a profit.
● The proposal was for the 2 new cinemas to be bought through a subsidiary company. The
lessors required the subsidiary have a paid up capital of $5000p.
● Regal Hastings only had 2000p available. Thus, the opportunity was going to be lost unless
someone else came up with the money.
● The directors and some related contacts were able to come up with the remaining 3000p so
that the subsidiary was sufficiently capitalised for the transaction to take place.
● The subsidiary was formed with 5000p share capital (Regal Hastings having 2000 shares, and
the directors and some others having 3000 shares).
● The shares in the companies were then sold. On the sale of the shares in the subsidiary
company, a profit of 2p per share was made.
● By this point, the shares in Regal Hastings had also been sold. The new shareholders,
somewhat opportunistically, said that the directors of Regal had made an unauthorised profit
on the sale of the shares of the subsidiary in their position arising out of their position as
directors. They caused the company to bring a case against the directors, seeking an account
of the profit they had made.
● The directors argued that this transaction could not have gone ahead without their investment.

Held (HL):
● It is an absolute duty not to make a profit for your position as a director unless the company
consents.
● Liability arises from the mere fact of a profit having, in the stated circumstances, been made.
The profiteer, however honest and well intentioned, cannot escape the risk of being called
upon to account.

19
 ● It was irrelevant that the transaction would not have been able to go ahead without the
support / investment of the directors.
● The directors could have avoided liability by getting the shareholders to confirm by way of
resolution that they were happy for the directors to make that profit, either before or after. In
the absence of that, they were liable to account for the profit.
● Thus, there was liability held even though the directors had acted in good faith, and what
where the best interests of the company.
○ This is an example of a situation where the duty not to profit from your position as a
director goes wider than the duty to act in the best interests of the company. Here, the
transaction was clearly in the best interests of the company, and only went
ahead because the directors helped out, but nevertheless the directors were
held liable.

Duty 2: A director must not pursue business opportunities having a connection to the company’s
business, unless the company consents

What is a corporate opportunity?

● This can be a bit of a grey area.
● ‘Corporate opportunity’ definitely includes “maturing business opportunities” that the company is already
interested in, but which the directors then intercept for their own benefit - Canadian Aero Service v
O’Malley
● ‘Corporate opportunity’ also probably includes any opportunity that fits with the existing lines of business -
e.g. Presley v CallPlus; Bhullar v Bhullar; Industrial Development Consultants v Cooley
○ We will look at Bhullar v Bhullar as an example.
○ Note that it is irrelevant whether the company could or would have taken up the opportunity
(Bhullar v Bhullar)

Bhullar v Facts:
Bhullar ● Joint venture company called BBL founded by 2 brothers - Mohan and Sohan.
● The shares in BBL were owned equally between the families of the 2 brothers.
● Main business of the company was operating supermarkets, but also interested in commercial
property investment- owned property called Springbank Works which included a lease premises
to a tenpin bowling operator.
● Relations between the 2 families broke down. At a board meeting, Mohan’s family told
Sohan’s family that they did not want anymore properties to be acquired by the company,
and Sohan’s family accepted that in principle.
● By accident when taking a foreign visitor to go tenpin bowling at Springbank Works, a member of
Sohan’s family became aware that a neighbouring property White Hall Mill, was up for sale.
● Sohan’s family took legal advice and then decided to acquire White Hall Mill in its own name. It
set up a special purpose subsidiary called Silvercrest for that purpose.
● Later, Mohan’s family became aware of this transaction and brought a claim seeking to bring a
derivate action against Sohan’s family and Silvercrest, saying this property had been acquired in
breach of Sohan directors’ duty not to usurp corporate opportunity of BBL, and Silvercrest should
be held to be holding White Hall Mill in trust for BBL.
○ Argument was that the opportunity should have been put to the BBL board - BBL is in
the business of property investment, White Hall Mill is right alongside one of our existing
properties, and this clearly would have been a good investment for BBL.

Held:
● Argument succeeded in the English HC and was upheld by English CA on appeal.

● It was held irrelevant whether BBL could or would have taken advantage of the
opportunity, had the BBL Board been made aware of it. The fact was that this was a
corporate opportunity that would have been of interest to BBL, and it was a breach of
fiduciary duty for the Sohan directors to usurp that corporate opportunity without the consent of
BBL.

● The fact Sohan’s family only became aware of this opportunity in a casual / accidental
way, and not because of their position as directors of BBL, was irrelevant. The Sohan
directors, having become aware of the opportunity that was within the existing lines of business

20
 of BBL, should have communicated that to the BBL Board and sought consent of BBL to
Silvercrest taking up the corporate opportunity.

● The argument that Mohan’s family had told Sohan’s family at an earlier board meeting that
they did not want to do anymore business with them or acquire any more properties was
also rejected. This did not amount to consent to Sohan’s family taking up this particular
opportunity.

a) Board Approval vs Shareholder Approval

● In the slightly controversial case of Queensland Mines v Hudson, the Privy Council held that a director
was not accountable for usurping a corporate opportunity, when other directors consented to him taking up
a particular mining licence.
○ There is some dispute as to whether that consent of the board of the company was sufficient.

● However, the duty not to usurp a corporate opportunity is a subset of the broader duty not to make an
unauthorised profit from your position as a director.
● Peter Watts would argue, consistent with the approach in Regal Hastings, that any relaxation of the duty
not to profit from the director’s position / not to usurp a corporate opportunity, should only be made by the
shareholders of the company.
○ In Regal Hastings, the HL said that the directors could have protected themselves by obtaining a
resolution of shareholders, either before or after. Having not done so, the directors of Regal
Hastings were held accountable for the profit that they had made.
○ In Queensland Mines v Hudson there was no such shareholder’s resolution. It was only an
approval by the board of the company that the director could take up the particular licence that
would have been a corporate opportunity.
■ Peter Watts says maybe that board approval was not sufficient.

● Even assuming board approval was enough, that is not what happened in Bhullar v Bhullar, and so the
case can be reconciled with Queensland Mines in that sense.
○ In Bhullar v Bhullar, there was only a general agreement at an earlier board meeting that the
company BBL would not do any more property investment. The particular proposal of the Sohan
directors taking up the White Hall Mill opportunity was never put to the BBL board. In fact, after
taking legal advice, the Sohan directors made the specific decision not to tell anyone about it, and
just go ahead and do it.
○ By contrast in Queensland Mines, the director put the particular proposal to the board and
obtained specific consent.
■ Equivalent in Bhullar would have been if the Sohan directors had gone to the BBL board
and said White Hall Mill is on the market, you don’t want to do anymore deals with us, can
we the Sohan directors take up the opportunity to buy it? If the Board said that was fine,
then of course the case would have been on all fours with Queensland Mines.

b) Company declines the opportunity?

● In Warman International, the High Court of Australia specifically held that liability was not prevented by
the fact that the company itself was not willing to take up the opportunity.
○ This shows how strict the duty is.
○ Even where the company is not willing or able to take up the opportunity (e.g. Regal Hastings -
company could not itself take up the leases without the investment of the directors), the directors
can still be liable for their corporate opportunity or profit unless there is specific consent given.

● Key passage from Warman International that stands for that proposition:
● “Thus, it is no defence that the plaintiff was unwilling, unlikely or unable to make the profits for
which an account is taken or that the fiduciary acted honestly and reasonably. So, in Regal
(Hastings) Ltd v Gulliver, although the directors acted in good faith and in the interests of the
company of which they were directors in taking up shares in a subsidiary which the company could
not afford to take up, they were held accountable for the profit made on the sale of the shares.
21
 And, in Phipps v Boardman, the solicitor was held accountable for the profit he made,
notwithstanding that he acted bona fide and in the interests of the trust and that the opportunity
would not have been availed but for his skill and knowledge.”

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3+(0*0%"*#)4+#<)3+#$/#&'+#B%)43;#

INTERESTED TRANSACTIONS:

Is it an interested transaction? (s 139)

Section 139:
● (1) Subject to subsection (2), for the purposes of this Act, a director of a company is interested in a
transaction to which the company is a party if, and only if, the director -

○ (a) is a party to, or will or may derive a material financial benefit from the transaction; or

○ (b) has a material financial interest in another party to the transaction; or

○ (c) is a director, officer, or trustee of another party to or person who will or may derive a material
financial benefit from, the transaction, not being a party or person that is:
■ (i) The company’s holding company being a holding company of which the company is a
wholly-owned subsidiary; or
■ (ii) A wholly-owned subsidiary of a holding company of which the company is a wholly-
owned subsidiary; or
● I.e. this is an exception that if you are a director of the other party to the
transaction, but that other party is a related company (holding company or wholly
owned subsidiary), then that is not deemed to be interested. But otherwise, if the
director is a director of the other party to the transaction, that will be considered to
be an interested transaction.

○ (d) is the parent, child, spouse, civil union partner or de facto partner of any party to, or person who
will or may derive, a material financial benefit from, the transaction; or

○ (e) is otherwise directly or indirectly materially interested in the transaction.

■ Unlike (a) - (d), there is no reference to material ‘financial’ benefit here.
■ One possible example that Peter Watts suggested to me that (e) might cover, is a situation
where a director only enters into a transaction b/c the other party to the transaction says
that if you don’t get the company to enter into this transaction, I am giong to report you to
the police b/c I saw what you were doing on the weekend. That might perhaps be
considered to be a material interest in the transaction, even though it is not a material
financial interest.

Example of exception in s 139(c) to interested transaction:

● Group of companies with a wholly owned holding company that owns 100% of shares in the subsidiary.
○ Directors A and B are the directors of the holding company
○ Directors A and C are the directors of the subsidiary company

● The holding company is selling a property to the subsidiary. Normally under s 139(c) you would say that is
an interested transaction because A is a director of both companies. However, because the two companies
involved are 100% holding company and subsidiary, then that exception in s 139(c) applies. A is deemed
not to be interested even though he or she is a director of both companies.

22
Section 139(2): [Another exception to the definition of what amounts to an interested transaction]
(1) For the purposes of this Act, a director of a company is not interested in a transaction to which the
company is a party if the transaction comprises only the giving by the company of security to a third
party which has no connection with the director, at the request of the third party, in respect of a debt or
obligation of the company for which the director or another person has personally assumed responsibility in
whole or in part under a guarantee, indemnity or by the deposit of a security.

Example:
● Fairly common situation where the bank says to company ABC Ltd - you want a loan, you are a small
company, I need 2 things from you by way of security: mortgage over company property and a personal
guarantee from your directors.
● Is the director interested in the mortgage that the company is giving? Technically, you might say yes
because by giving the mortgage it is less likely that the ANZ is going to have to call on the other form of
security that the ANZ has required which is the guarantee from the director himself or herself. So
technically you might say there is an interest. However, this is a very common standard transaction - the
director is really only providing the guarantee to support the loan being made to the company itself as
further security for that loan.
● The legislature has provided that in that situation, just because the director is also providing a guarantee,
the director won’t be deemed to be interested in the mortgage that the company is providing to the Bank.

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&+4<*#%2#30*(5%*-4+#-"3+4#*#6H[#)"3#.%&+"&0)5#)@%03)"(+#-"3+4#*#6H6

Disclosure (s 140)
(1) A director of a company must, forthwith after becoming aware of the fact that he or she is interested in a
transaction or a proposed transaction with the company, cause to be entered in the interests register, and,
if the company has more than 1 director, disclose to the board of the company -
(a) If the monetary value of the director’s interest is able to be quantified, the nature and monetary value
of that interest; or
(b) If the monetary value of the director’s interest cannot be quantified, the nature and extent of that
interest.

(2) For the purposes of subsection (1), a general notice entered in the interests register and, if the company has
more than 1 director, disclosed to the board to the effect that a director is a shareholder, director, officer or
trustee of another named company or other person and is to be regarded as interested in any transaction
which may, after the date of the entry or disclosure, be entered into with that company or person, is a sufficient
disclosure of interest in relation to that transaction.
● I.e. a general notice can be sufficient.

(3) A failure by a director to comply with subsection (1) does not affect the validity of a transaction entered into by
the company or the director.
(4) Every director who fails to comply with subsection (1) commits an offence and is liable on conviction to the
penalty set out in s 373(2).

Requirements:
● Once a director becomes aware of the fact that they are interested in a transaction, they must enter their
interests on the interest register of the company, and disclose it to the Board of the company - s 140(1).

● A general notice is sufficient disclosure - s 140(2).

● Failure to disclose is an offence (s 140(4)), however it will not invalidate the transaction - s 140(3).

Exception - S 140(1A):

23
 (1) A director of a company is not required to comply with subsection 1 (i.e. disclose) if -
● (a) The transaction or proposed transaction is between the director and the company; AND
● (b) The transaction or proposed transaction is or is to be entered into in the ordinary course of the
company’s business and on usual terms and conditions.

,#Example: Directors of Vodafone NZ have a mobile phone contract with Vodafone on normal terms and
conditions. The argument behind this provisions is that in a situation like that, it would be a waste of time /
unnecessary to require the directors to formally disclose those contracts. As long as they are in the ordinary course
of the company’s business and on usual terms and conditions, then that should be enough and no formal
disclosure is required.

Example:
● ABC Ltd and XYZ Ltd enter into a particular contract.

● Director A is on the boards of both companies. The companies are not related (e.g. not parent and
subsidiary), and so therefore this is an interested transaction under s 139(1)(c).

● Director can then disclose the fact of the interest on the interest register of both companies, and to the
Board of both companies - s 140(1)
○ I.e. disclosure must happen on both sides.

● Disclosure can be general per s 140(2)

○ A could give a general notice under s 140(2) saying that any transaction that we have with that
other company, I will be interested in.
■ General disclosure = e.g. A is a director of another company.

● Failure to disclose will not invalidate the transaction - s 140(3).

● If the company does not receive fair value for the transaction, it will be voidable under s 141.

Avoidance of Interested Transactions under s 141:

● Under s 141, an interested transaction is only voidable if the company did not receive fair value - s 141(2).
The period for avoidance is limited to 3 months following the disclosure of the interest to all the
shareholders (whether by means of the company’s annual report or otherwise) - s 141(1).

● The question of whether the company received fair value under the transaction is determined on the basis
of the information known to the company and to the interested director at the time the transaction is
entered into - s 141(3).
○ So the company does a deal with a director - e.g. sells a property to a director. The director in fact
knows that the property is worth much more than the company realises. Then, the question of fair
value is going to be determined having regard to that director’s additional knowledge.

● There is a presumption that the company obtained fair value if the transaction was entered into in the
ordinary course of its business and on usual terms - s 141(4).

● The burden to establish fair value is on a person (third party) seeking to uphold a transaction and who
knew or ought to have known of the director’s interest at the time the transaction was entered into - s
141(5)(a). In any other case, the company has the onus of establishing that it did not receive fair value - s
141(5)(b).

● A transaction in which a director is interested can only be avoided on the ground of the director’s interest in
accordance with this section or the company’s constitution - s 141(6).
○ i.e. only voidable if fair value was not obtained, and within the 3 month time period. The CL /
equitable rules about avoidance of interested transactions have gone.

24
 ○ The other grounds on which a transaction could be avoided, might not necessarily be removed for
example you have a breach of fiduciary duty in s 131 - duty to act in best interests of the company.
The transaction might be voidable on that ground, and that would not be removed by subsection 6.

Protection Against Avoidance of Interested Transactions - Shareholder Unanimous Assent:

● If an interested transaction is not at fair value, then you can protect against the potential consequence of
avoidance within the 3 month period after the shareholders become aware of it, by getting unanimous
shareholder assent under s 107(3).
○ I.e. if all the shareholders agree that the transaction will be valid, s 141 will not apply, whether in
fact fair value was given or not.

● The unanimous shareholder assent must be in writing - s 107(4). However, in this particular case, the
solvency test need not be complied with.

Can there be avoidance at equity?

● The old equitable rule under which interested transactions could be set aside at equity unless there was
shareholder approval, has gone. S 141(6) says that a transaction in which a director is interested can only
be avoided on the ground of the director’s interest in accordance with this section (s 141) or the company’s
constitution.
○ I.e. if there is not fair value, then the transaction can be avoided under s 141(1).
○ However, if fair value was obtained, or it was not but the 3 month time period has expired, then you
cannot avoid the transaction under s 141 and neither can you then fall back on the old equitable
rule.

● However, you might still be able to fall back on old equitable rules in relation to transactions in breach of
duty to act in best interests of the company being voidable, unless the other party is innocent. There is no
reason why those rules would not continue.
○ We discussed that in relation to Autumn Tree (footnote passage - CA says if you breach s 131
duty that would make transaction voidable)
○ Kinsela v Russell - example of again a breach of fiduciary duty to act in best interests of the
company, the directors caused the company to enter into a lease transaction in breach of that duty
and the lease was held to be voidable in that case.

● Compliance with interested transaction rules, does not override the need to comply with s 131 (Hedley v
Albany).
○ Just because a transaction is not voidable under s 141, it may not be voidable under the equitable
rule relating to interested transactions either, but that does not mean that the transaction might not
be voidable for breach of s 131, assuming that there is a breach of s 131.

● Unanimous shareholder assent under s 107(3) in writing of an interested transaction does enable a
transaction to go ahead, regardless of s 141.
○ However, if you are applying the rule suggested in Autumn Tree and Kinsela that a transaction is
voidable at equity because it it is a breach of fiduciary duty to act in the best interests of the
company, you would be concerned with unanimous assent applying by way of the CL principles
of ratification or release of breaches of director duties.
○ Unanimous shareholder assent can only apply to ratify / release a breach of fiduciary duty such as
as s 131 if the company is solvent - Sojourner v Robb, Sequana. Unanimous assent of
shareholders will not be effective to ratify or release a breach of s 131 if the company is insolvent
or likely insolvent.

Interested Transactions - is there Actual Authority? [COMPANY CONTRACTING]

● Another issue that might arise in relation to interested transactions, is whether the board or the relevant
company officers had actual authority to enter into the transaction?

25
 ● Default position under the CA 1993 is that when a director is interested in a transaction they can vote and
be included in the quorum - s 144 of the Act specifically provides for that.

● However, a company may restrict the default rules in their constitution.

○ A listed company will definitely do so - the listing rules do not allow a director to vote on a
transaction in which they are interested, or be included in a quorum.
○ Even some companies that aren’t listed may have restrictions in their constitution on interested
directors in relation to transactions where they are interested.

● If the company constitution restricts the ability of interested directors to vote or be included in a quorum,
and those restrictions are not complied with and that makes a difference as to whether the resolution would
have been passed or not, then that will REMOVE ACTUAL AUTHORITY FOR THE TRANSACTION.
○ There might still be apparent authority if you apply the normal rules for apparent authority - holding
out etc, then potentially there could be apparent authority even if there was not actual authority.

Section 145 - Use of Inside Information

● S 145 controls the use of inside information generally. This could be seen as one aspect of director
profiting from its position, but s 145 certainly not as wide as the CL, and the CL rules relating to not
profiting from your position (e.g. cases like Regal Hastings) and not usurping a corporate opportunity
(cases like Buhller v Buhller) would continue to apply.

● Another aspect of use of inside information relates to insider trading - where a director has commercially
sensitive info / price sensitive info and uses that to acquire or sell shares in a company to the director’s
advantage, that potentially gives rise to issues under s 149 of the Act in relation to ordinary companies and
for companies that are public issuers (listed companies and other companies that have issued shares to
the public) then there is a regime of insider trading covered by financial markets conduct act. We are not
going through the detailed rules in that, but we will go through s 149 rules relating to non-public companies
next week.

Section 145
(1) A director of a company who has information in his or her capacity as a director or employee of the
company, being information that would not otherwise be available to him or her, must not disclose that
information to any person, or make use of or act on the information, except -
(a) For the purposes of the company; or
(b) As required by law; or
(c) In accordance with subsection (2) or subsection (3); or
(d) In complying with s 140.
(i) S 140 is section that requires directors to disclose interests.

Section 145(2) and (3)

(2) A director of a company may, unless prohibited by the board, disclose information to -
(a) A person whose interests the director represents; or
(b) A person in accordance with whose directions or instructions the director may required or is
accustomed to act in relation to the director’s powers and duties and, if the director discloses the
information, the name of the person to whom it is disclosed must be entered in the interests
register.

E.g. JV company. Director represents one JV shareholder. Then director is going to be able to pass information
back to appointing shareholder unless the board prohibits them from doing so. Or if the director is someone who
acts in accordance with someone else’s directions or instructions, then that person who gives them the instruction
is going to be a shadow director (s 126 and the definition of shadow director in s 126(1)(b)(i) and (ii)) and then
those same obligations of confidentiality will apply to that person (that shadow director).

(3) A director of a company may disclose, make use of, or act on the information if -
(a) Particulars of the disclosure, use, or the act in question are entered in the interests register; and
26
 (b) The director is first authorised to do so by the board; and
(c) The disclosure, use or act in question will not, or will not be likely to, prejudice the company.

So that is a fairly restrictive provision. Does not really allow much freedom to directors to disclose, make use of or
act on sensitive company information, because they can only do so if they are given the right to by the board, and
the disclosure is not going to prejudice or be likely to prejudice the company. So that is a fairly restrictive provision.

➔ Not sure whether s 145 could be used in a situation where you have former directors. However, it is
possible the Court might say that you should not be able to avoid the application of the section, just by
resigning.

INSIDER TRADING
(S 149 and / or fact based personal fiduciary duty)

This is concerned with the sale / purchase of shares in the company, by a director of the company. The company
itself is not a party to the transaction. This is dealt with by s 149 (note - it does not apply to public issuers - insider
trading in that context is dealt with by the FMCA).

Note that these would be duties owed to the shareholder, and so they can be directly enforced by the shareholder
under s 169.

SECTION 149:

a) S 149 - Key Provisions

● S 149(1) applies if:

○ The director has, in capacity as director or employee, information that would not otherwise be
available to him or her, but which is information material to an assessment of the value of the
shares issued by the company.
■ The director will almost always have price sensitive information that is not publicly
available - knows what the company is doing, access to meetings / minutes, other
information about the management of the company, etc.

● If s 149(1) applies, then:

○ The director can only acquire shares if the consideration paid is not less than the fair value of the
shares - s 149(1)(a)
● The director can only sell shares if consideration received is not more than the fair value of the
shares - s 149(1)(b)

● Fair value of the shares is determined on the basis of all information known to the director or publicly
available at the time - s 149(2).

● If breach s 149, then liable to the other party for the difference between the consideration paid / received
and fair value.
○ Where a director acquires shares in contravention of subsection (1)(a) [i.e. for less than FV], then
the director is liable to the person from whom the shares were acquired for the amount by which
the FV of the shares exceeds the amount paid by the director - s 149(4)
■ I.e. director has to top up the other party
○ Where a director disposes of shares in contravention of subsection (1)(b) [i.e. for more than FV],
the director is liable to the person to whom the shares were disposed for the amount by which the
consideration received by the director exceeds the fair value of the shares - s 149(5).
■ I.e. director has to give the excess back to the other party.

● Nothing in s 149 applies to financial products that are quoted on a licensed market - see FMC Act - s
149(6)

27
 b) S 149 - Fair Value Issues

Other party has the inside info?

● If s 149 applies (the director does have commercially sensitive information that is relevant to the price of
the shares), then the transaction (sale or purchase of shares) must take place at fair value, and that is so
even when the other party has the inside information - Thexton v Thexton (2002) (CA)
○ Thexton involved purchase of shares by son from father, where both parties would in fact have
had the relevant inside info, but nevertheless there was still an obligation for the director buying
shares to trade at fair value.

Discount on FV for minority stake?

● What is fair value can give rise to some interesting issues about where FV should take into account a
minority discount.
○ If you were buying and selling all the shares in the company, then might look at the overall net
asset position of the company and divide that by the number of shares. But if you are only looking
at a small parcel of shares, then that proportionate amount of the net asset position of the
company might be discounted somewhat to reflect the fact that a smaller parcel of shares does not
give you control and is not as marketable.

● However, there is some authority for the proposition that where you have got a small company which is
essentially like a quasi corporate partnership, then the assessment of fair value should not include such a
minority discount - Fong v Wong (NZCA and SC)
○ SC is a refusal for leave judgment but still supports that proposition.

Date for Assessing FV?

● Date for assessing fair value is the date the shares are acquired. The word “acquire” does not include a
conditional contract, and may even require the actual transfer of the shares (Cooper Davies) (2015) (NZ
CA)

c) Acquiring / Disposing of Shares through a Corporate Vehicle

● It is unclear S 149 applies where a director acquires or disposes of shares through the use of a corporate
vehicle. JL would contend that the use of a corporate vehicle enables a director to avoid the application of s
149.
○ Susan Watson has taken an inconsistent position in her text. In 2013, she said it would not apply,
but in 2018 she suggested it may apply.
○ In Cooper Davies, the Court assumed that s 149 would apply where a director acquired or
disposed of shares through a corporate vehicle, however there was no specific discussion of the
matter.

Legislative History
● The Law Commission Draft Act and Companies Bill would have made it clear that a share acquisition or
sale by a director through a corporate vehicle would have been caught by s 149 (then s 125). Under
subsection (4), there was a definition of interest in a transaction where shares were held through a
corporate vehicle, essentially controlled by the director. That was intended to be an anti avoidance
provision to ensure that when directors were buying or selling shares, not just in their own name but say
through a corporate vehicle, or some other interest in shares, that liability to ensure that the transaction
was at fair value was going to extend to all those situations as well.

● However, those anti-avoidance provisions were not retained in the final version of the Companies Act as
passed.

● What was provided instead was definition of relevant interest in s 146(2) is relevant to disclosure of share
acquisition and share sales by a director through a corporate vehicle so for the purpose of s 148, but that
definition does not apply to section 149.
28
 ○ Therefore, don’t think s 149 would apply where there is use of a corporate vehicle.

Extension of Purpose Argument from Fong v Wong:

● S 149 applies where a director is buying or selling shares in their capacity as trustee of a family trust (Fong
v Wong (SC), Holmes v Kiruwai).

● The rationale according to the SC in Fong v Wong is that an argument to the contrary would subvert the
obvious purpose of the section.

● This ‘purpose’ argument is not particularly helpful, given that the wording of s 149 is clear. It talks about
directors acquiring or disposing of shares. As it happens, the proposition in Fong v Wong that s 149
applies where the director acquires or disposes of shares in their capacity as trustee of a family trust is
consistent with that wording, as in such a context the director is the legal owner of the shares

● This is further supported by s 92, which provides that no notice of a trust, whether express, implied or
constructive, may be entered on the share register.
○ Therefore, we do not know who the beneficial owners of the share held by the family trust are -
only the trustees who are the legal owner of the shares. If the sale or purchase is by the director as
trustee, they are the ones acquiring or disposing of the shares and so it is consistent with that
wording.

● That purpose argument from Fong v Wong could potentially be extended to dealing with sale or purchase
through a corporate vehicle.
○ In Insurego v Harris (2013) (NZ HC), the Associate Judge would have extended the ‘purpose’
argument from Fong v Wong regarding directors acquiring or disposing of shares in their capacity
as trustee of a family trust, to a director acquiring / disposing of shares through the use of a
corporate vehicle. However, arguably that is not good law.
○ The purpose argument is much weaker in the context of a corporate vehicle, because it is so
inconsistent with the wording of the section, which talks about a director acquiring or disposing of
shares. Acquisition or disposal of shares by a corporate vehicle is not by a director, because the
corporate vehicle is a separate legal entity in its own right from its shareholders and the director.
You cannot identify the corporate vehicle with the director.

Piercing of the Corporate Veil - Prest v Petrodel:

● If the sale or acquisition of shares by a director through a corporate vehicle is not caught by s 149, there is
a query as to whether s 149 should nevertheless be deemed to be apply by use of the piercing of the
corporate veil from Prest v Petrodel.
○ It might depend on whether the particular company has been set up to EVADE (better word than
‘avoid’) the application of s 149 perhaps.

● Test = If someone is subject to an existing legal obligation, which he or she deliberately evades by
interposing a company under his or her control, then the Court can pierce the corporate veil.

● Situation where the director has set up the corporate vehicle for the specific purpose of evading
the s 149 duty, where it is clear that the director is acting abusively.
○ The director already has some of the shareholding in the company and wants to up the rest of the
shares. There is a clear amount of commercially sensitive information that is relevant to the value
of the shares that the director is fully aware of and the director knows that they are going to be
buying more shares at a price that is vastly different from the true market price of the shares (e.g.
that something is going to happen to the company so the shares are worth more than he is
prepared to pay for them) and the director becomes aware of section 149 that they have to pay fair
value if they buy the further shares in their own name. Accordingly, the director deliberately sets up
a corporate vehicle for the specific purpose of enabling that transaction to take place without s 149
applying.

29
 ■ In that specific situation, the Court might accept an argument of the principle of piercing
the corporate veil because the director is deliberately evading an existing legal obligation
under s 149, and is doing so by disposing a company under his or her control.

Personal Fiduciary Duty:

● If all else fails and s 149 does not apply, there might be another argument that the director who is buying
out the other shareholder, might have a personal fiduciary duty.
○ See Holmes v Kiriwai.

● Normally the directors only owe fiduciary duties to the company. However, in some circumstances it has
been held that directors engaging in share dealings may owe a duty to the other shareholder, perhaps in
situations where the director has a position of power - has access to all the information about the company
and the shareholder doesn’t, shareholder is reliant on them entirely for information, is particularly
vulnerable, maybe even of ill health.
○ In certain specific situations involving vulnerability and a degree of confidence reposed in the
director, there can be situations where a director purchasing shares from another shareholder can
be held to owe them a personal fiduciary duty, and that potentially can give rise to a breach of
fiduciary duty and liability to the other shareholder where the parties have transacted at a price that
is not really a fair price in circumstances where the director has not disclosed the information
about the true value of the company.

● Remedy for breach of fact based fiduciary duty is either damages (difference between the amount received
for the shares and the amount that would have been received had the relevant disclosure been made), or
recission of the contract.

Holmes v Kiriwai Consultants (2015) (NZ CA) and [2015] NZCA

The plaintiff (outgoing shareholder) was able to successfully bring a case based on s 149, and thereby increase the
purchase price paid by the other shareholder who was also a director from 1 million to just over 4 million dollars, on
the basis that the fair value for the shares was $4 mil rather than $1 mil purchase price.

Facts:
● Holmes Ventures Ltd had 2 shareholders:
○ Holmes Family Trust (90% shareholding)
○ Kiriwai Consultants - corporate vehicle of Mr Emmens (10% shareholding).
● Kiriwai Consultants sold out its 10% shareholding to the Holmes Family Trust for $1 million, which was not
held to be fair value. This was because Holmes Ventures Limited owned a very valuable marshalling
company that Mr Homes (the director of the company and trustee of the Holmes Family Trust) was aware it
was about to sell at a very good price and produce a substantial cash flow for the company, but did not tell
Mr Emmens about. This was also held to be in breach of personal fiduciary duty by Mr Holmes.

Timeline:
● Mr Emmens was the general manager of Holmes Ventures Ltd. Under the shareholder’s agreement,
Kiriwai Consultants was required to sell its shares if Mr Emmens’ employment stopped. In Sept 2012, Mr
Emmens’ position as general manager was disestablished.
● A few months later (3 - 4 Nov), Port of Tauranga approached Mr Holmes (sole director of Holmes
Ventures), to ask if its subsidiary Quality Marshalling was for sale.
● 5 Nov 2012 - Mr Holmes, told Emmens that Kiriwai was required to sell its shares, and offered for the
Holmes Family Trust (of which he was the trustee) to buy them for $1 million.
○ Mr Holmes as sole director did not tell Mr Emmens that the Port of Tauranga had made the
approach in relation to Quality Marshalling, but obviously that was important information and highly
relevant to the value of the shares in Holmes Ventures.
● 8 Nov 2012 - Mr Holmes emailed his accountant saying I think I have won Lotto - I think I have sold Quality
Marshalling for $34 million.
○ I.e. By this stage, the negotiations between Mr Holmes and port of tauranga for sale of Quality
Marshalling were such that it was pretty clear that Holmes Ventures was going to be able to sell
30
 Quality Marshalling for $34 million, which would bring in a huge amount of cash into Holmes
ventures.
○ Even if Quality Marshalling was the only asset that Holmes Ventures had (it wasn’t - there some
other minor assets), if $34 mil cash comes into the company, you would have thought that 10% of
the shares in Holmes Venture was worth at least $3.4 million (1/10 of $34 mil) , and yet despite
that Mr Homes had been offering to buy the 10% shares for only $1 million.
● 14 Nov 2012 - Mr Holmes goes back to Mr Emmens again and does not disclose this inside information
about the prospective sale. He re-states the offer that the Holmes Family Trust will buy Kiriwai’s
shareholding for $1 million on a “take it or leave it” basis.
● 15 Nov 2012 - Mr Emmens was not particularly well and had been on stress related sick leave. His position
as general manager had been disestablished, and he felt that he had no choice but to accept the $1 million
offer for the shares.
● Just over 2 months later, the settlement takes place of the sale of Quality Marshalling to Port of Tauranga
for $34 million
○ When Mr Emmens hears about that - he is upset because he sold his stake in Holmes Ventures for
$1 mil when clearly it was worth at least $3.4 million, if not a bit more.
○ He goes to Court and sues the Holmes Family Trust to try and get the additional amount above the
$1 mil that would have been fair value for the shares.

Causes of Action:
● S 149:
○ The first cause of action is based on s 149 saying that Mr Holmes, as a director of Holmes
Ventures Ltd, has purchased Kiriwai’s 10% shareholding for $1 million (albeit in his capacity as
trustee of the Holmes Family Trust), while being in possession of information that is material to the
share price (the prospective sale of Quality Marshalling for $34 million). Under s 149, he was
obliged to not purchase the shares for any less than fair value, and so he should be liable to pay
me the difference between fair value ($4.1 mil and the purchase price paid of $1 million).

● Breach of Personal Fiduciary duty

○ The second cause of action is based on personal breach of fiduciary duty by Mr Holmes to Mr
Emmens and Kiriwai Consultants.

S 149 Claim:
● The s 149 cause of action succeeded in both the HC and the CA.
● The CA said you need to look at the fair value of the shares at the time of the agreement between the
Holmes Family Trust and Kiriwai Consultants - 15 November.
○ Of course, the Holmes Family Trust argues that it was not certain that the sale of Quality
Marshalling was not absolutely certain then, and so maybe you can’t take that into account.
○ However, the CA says that as at 15 Nov, the likelihood of the sale of the subsidiary was almost
certain, and you can take that fact into account in assessing the value of shares as at 15 Nov
2012.
○ The CA allowed a small 5% discount to reflect the risk that the sale might possibly not
proceed.
● Overall, the CA assessed the FV of the 10% stake in Holmes Ventures as being just over $4.1 mil rather
than $1 mil, and so the liability of Mr Holmes to Kiriwai Consultants was the difference between those 2
figures - damages award under s 149 of about $3.1 million.

,#L+<+<$+4#%2#(%-4*+#&')&#&'+#.-4(')*+#%2#&'+#*')4+*#=)*#$/#&'+#\%5<+*#O)<05/#M4-*&#4)&'+4#&')"#$/#I4#\%5<+*#
0"#'0*#.+4*%")5#().)(0&/;#\%=+@+4#)1)0"E#(%"*0*&+"&#=0&'#&'+#)..4%)('#&)F+"#0"#%&'+4#()*+*#50F+#Fong v Wong, it
was accepted that s 149 did apply in the situation where Mr Holmes was purchasing shares in his capacity as
trustee of the family trust. That must be right - s 149 talks about the acquisition or disposition of shares by a director
- well Mr Holmes is still acquiring the shares. He is the legal owner of the shares even though they are being
purchased as trustee for the family trust. So no problem with that.

Breach of Fiduciary Duty Claim:

31
 ● The alternative argument made in this case was based on breach of shareholder personal fiduciary duty.
This was relying on an earlier very famous CA case called Coleman v Myers from 1977.

● The CA here in Holmes v Kiriwai said that the existence of a statutory remedy under s 149 does not
preclude recognising a fact-based fiduciary duty [59].
○ I.e. the fact there is potential liability under s 149 does not mean there could not alternatively be
liability under the personal fiduciary duty.

● Normally, of course directors of a company owe their fiduciary duties to the company to act in the
company’s best interests and for proper purposes. You would not normally as a director owe fiduciary
duties to other shareholders, but you can in certain circumstances.

● Question of whether there is a fact-based fiduciary relationship will depend on factors such as reliance,
confidence and trust between the parties, imbalance of power and knowledge between the parties and
vulnerability [54].

● DUTY: On the facts of the case, there was a personal fact based fiduciary duty based on the imbalance of
knowledge and power between Mr Holmes and Kiriwai.
○ Mr Holmes was the sole director of Holmes Ventures Ltd - had all the knowledge about what was
going on in the company, knew about the proposed deal with Port of Tauranga.
○ Kirwai, through Mr Emmens, did not have access to any of that info except as provided by Mr
Holmes. In particular, Mr Emmens had been ill and on stress related leave, he was no longer
working as general manager and so he did not have access to the info he would normally have. He
was in a vulnerable difficult position and was entirely dependent on Mr Holmes for information
about the company, and felt he had no choice but to agree to the $1 mil purchase price.

● BREACH: The personal fiduciary duty was held to have been breached by Mr Holmes’ failure to disclose
the fact of negotiations with the Port of Tauranga.
○ i.e. liability for breach of fiduciary duty is not because of the transfer at other than FV as such, but
rather because where the fiduciary relationship exists, there is an obligation on the director
who has the fiduciary duty to make disclosure of relevant facts before entering into the
transaction.
○ Therefore, breach of fiduciary duty can give rise to a different measure of damages than under s
149, if there is also a breach of s 149.
■ ,#\+4+E#&'+4+#=)*#50)$050&/#%"#$%&'#()-*+*#%2#)(&0%"E#$-&#&'+#<+)*-4+#%2#3)<)1+*#=)*#
*%<+=')&#'01'+4#%"#&'+#)5&+4")&0@+#()-*+#%2#)(&0%"#0"#&'0*#()*+#$)*+3#%"#$4+)('#%2#
203-(0)4/#3-&/#&')&#=)*#%=+3#%"#&'+#2)(&*;#

● QUANTUM: The quantum of damages for breach of personal fiduciary duty was based on the difference
between what the shareholder received for the shares ($1 mil), and what would have been received
if the disclosure had been made ($4.287 mil).
○ Thus, not specifically looking at the difference between the amount paid and the measure of fair
value at the time of the agreement, which was the measure of damages for breach of s 149. We
are looking at what would have been received, if disclosure has been made.
○ If the disclosure had been made, then Kiriwai (Mr Emmens) would have waited for the sale
to go through, and then ensure that it received its fair share of that - value company based on a
share of that cash and any other assets that Holmes ventures had.
○ That therefore meant that the measure of damages for breach of fiduciary duty did not take
into account any discount for lack of complete certainty (as under s 149). That was not
necessary for the purpose of this remedy.

Remedies for Breach of Fact-Based Fiduciary Duty:

For breach of personal fact-based fiduciary duty, you can get EITHER:
32
 ● Equitable damages
○ Difference between the amount paid / received for the shares and what would have been paid /
received if the relevant disclosure had been made.
● OR Recission of the contract
○ Contract for the sale and purchase of shares is voidable at equity for breach of fiduciary duty,
unless the other party is innocent (obviously won’t be here), contract has been affirmed, or there
has been undue delay or the parties cannot be put back into their original positions.

,#!"#Holmes, this was not really an issue because Mr Emmens was not really looking for any remedy other than
damages.
● However, if you had a situation where your client has been duped by a director like Mr Holmes who has not
told you about the full value of the company - you have been almost tricked essentially into selling the
shares, not realising what the true value is - and then you find about this and rather than getting damages
for the difference in value under s 139, or damages arising from what you might have accepted if you had
known / had full disclosure of the relevant information, maybe rather than that you might say well look I
would actually rather not be bound by the contract that I agreed to to sell my shares. I would rather
avoid that contract and be back in the company again now that I know the full picture.
○ S 149 does not give you that option. However, breach of a fact based fiduciary duty does -
potentially another remedy that equity gives you so it is worth being aware of.

,#Coleman v Myers: (CA) (1977)

● Another case where a director persuaded other shareholders to sell to him without disclosing full picture
● There was found to be a personal fiduciary duty owed on the facts, that was breached.
● However, the majority of the CA held that the right of rescission had been lost through the passage of time
and the inability to restore the parties to their original position.

Director’s Duty of Care (SECTION 137)

● This section replaces the CL duty of care.
● You could modify the CL duty of care in the company constitution, however s 137 cannot be contracted out
of in the same way. The statutory duty under s 137 applies regardless of what you might say in the
constitution.

● Note that continuing to trade a company when it is insolvent, can not only amount to reckless trading, but
also to a breach of the directors’ duty of care - Grant v Johnston (CA).

Section 137 - Companies Act 1993:

A director of a company, when exercising powers or performing duties as a director, must exercise the care,
diligence and skill that a reasonable director would exercise in the same circumstances taking into account, but
without limitation, -
(a) The nature of the company; and
(b) The nature of the decision; and
(c) The position of the director and the nature of the responsibilities undertaken by him or her.

,#*-$#9(:#]&'+#.%*0&0%"#%2#&'+#304+(&%4#)"3#&'+#")&-4+#%2#&'+#4+*.%"*0$050&0+*#-"3+4&)F+"#$/#'0<#%4#'+4^#0*#.4%$)$5/#
0"&+"3+3#)*#)#%"+#=)/#4)&('+&#-.=)43*E#*%#&')&#02#/%-#')@+#)#.)4&0(-5)4#.%*0&0%"#?#*+&#%2#4+*.%"*0$050&0+*#2%4#)#
.)4&0(-5)4#)4+)#9+;1;#!M#?#20")"(+:E#/%-#<01'&#$+#+Y.+(&+3#&%#')@+#)#'01'+4#_KP#$?(#%2#&'+#*.+(020(#*F055*#/%-#')@+#
)"3#&'+#4+*.%"*0$050&0+*#&')&#/%-#')@+#-"3+4&)F+";#
● However, just b/c you are not the finance director for example, does not mean that a certain base
level of due care and skill will not be expected of all directors. The courts have made it quite clear
that they will expect all directors to have certain base level of understanding of the company, its
business and its financial position. They will be expected to be competent in understanding the

33
 company’s financial accounts and be sufficiently informed to be able to really guide the company’s
business and to monitor the managers that work below the BOD.
○ Look for a finance director - Court may apply a higher duty of care given their specialist financial
skills having regard to s 137(c).
○ However, the Court will expect a degree of financial literacy from all directors - Davidson, Daniesl
v Anderson.

One example of this proposition that a certain base level of care and skill is expected of all directors is shown by
Davidson v Registrar

Davidson v Registrar (2011):

Facts:
● Mr Davidson was a commercial lawyer - partner in a leading firm. He was involved as a director or
chairperson of Bridge Corp, and he argued that I am a lawyer, that is my trade, you can’t expect me to be
on top of the financial matters relating to the company. We have got a finance director for that, and you
should not expect as much of me in respect of financial matters because I am really there on the board
because I am a good lawyer.

● Justice Miller rejected the suggestion that Mr Davidson could not be expected to be on top of the
company’s finances. This was in context of case where registrar of companies was seeking to uphold an
order that Mr Davidson be banned from being a director of companies for a period of time - he was seeking
to set that aside and Justice Miller refused to do that.

● “These observations lead me to the conclusion that Mr Davidson was not fully qualified for the office that he
held. I accept that the standard of care required of a director depends on his or her position and
responsibilities, but it also depends on the nature of the company and any given decision being made. A
director must understand the fundamentals of the business, monitor performance and review
financial statements regularly. It follows that a degree of financial literacy is required of any
director of a finance company.”
○ This is something that is expected of all directors - the director must understand the fundamental of
the business - what is the nature of the business and its fundamentals.
○ Justice Miller adds the words of a finance company - but those words were really only added
because this particular company was a finance company (Bridgecorp) - but don’t think the
position is any different for any other director of any other company. The courts will expect that a
degree of financial literacy is expected of any director of a company.

To what extent does s 137 apply to omissions?

● Section 137 talks about the need to have due care and skill “when exercising powers or performing duties”
- does this catch failing to act?
● Certainly at CL it did. If directors did not notice that their colleagues (other members of board) or senior
managers have been engaged in fraud, and proper monitoring would have spotted that, then they were
sometimes held liable under CL duty of care for failing to take the appropriate action
● Is that also the case under s 137?
● I think clearly it must be. There are certainly cases that are consistent with that such as the Oberholster
case in Case book - noted that s 130(2) contains an express duty on board to monitor people to
whom powers are delegated.

Section 130
(1) Subject to any restrictions in the constitution of the company, the board of a company may delegate to a
committee of directors, a director or employee of the company, or any other person, any 1 or more of its powers
other than its powers under any of the sections of this Act set out in Schedule 2

(2) A board that delegates a power under subsection (1) is responsible for the exercise of the power by the
delegate as if the power had been exercised by the board, unless the board—

34
 (a) believed on reasonable grounds at all times before the exercise of the power that the delegate would
exercise the power in conformity with the duties imposed on directors of the company by this Act and the
company’s constitution; and
(b) has monitored, by means of reasonable methods properly used, the exercise of the power by the
delegate.

● Have discussed in the context of company contracting.

● S130(2) - talks about the fact that the Board is responsible for the exercise of power by delegates. There is
clearly an obligation on directors to monitor those acting beneath them, and a failure to properly monitor
can lead to a breach of the section 137 duty.
● Another example of that is going to be the Daniels v Anderson case - failure by the CEO to appropriately
monitor the actions of a person / staff member engaged in foreign exchange dealings led to liability of the
CEO under the director’s duty of care. That was not the case under the statutory provision s 137, but I
would suggest the result of the case would have been no different under our law.

Section 138 - Use of Information and Advice:

● S 138 is quite relevant to the director’s duty of care cases.
● Allows directors to rely on reports and statements or expert advice that they might receive - might be from
other directors / committee of directors who have been entrusted on reporting on a particular area, or they
might be professional advisors or other experts.

(1) Subject to subsection (2), a director of a company, when exercising powers or performing duties as a
director, may rely on reports, statements, and financial data and other information prepared or
supplied, and on professional or expert advice given, by any of the following persons:
(a) An employee of the company whom the director believes on reasonable grounds to be reliable
and competent in relation to the matters concerned:
(b) A professional adviser or expert in relation to matters which the director believes on reasonable
grounds to be within the person’s professional or expert competence.
(c) Any other director or committee of directors upon which the director did not serve in relation to
matters within the director’s or committee’s designated authority.
(i) This subsection is very wide.

(2) Subsection (1) [i.e. ability to rely] applies to a director only if the director -
(a) Acts in good faith; and
(b) Makes proper inquiry where the need for inquiry is indicated by the circumstances; and
(c) Has no knowledge that such reliance is unwarranted.

,#*%#2)045/#4+)*%")$5+#*+(&0%"#&')&#0*#%2&+"#4+50+3#%"#='+"#(5)0<*#%2#$4+)('#%2#*#6V`#)4+#<)3+E#*%<+&0<+*#+@+"#

='+"#(5)0<*#2%4#$4+)('#%2#*#6V6#93-&/#&%#)(&#0"#&'+#$+*&#0"&+4+*&*#%2#&'+#(%<.)"/:;#

Section 138 cases:

● There have been a number of cases where section 138 was attempted to be relied on, and the courts have
given views as to whether section 138 could be relied on. In each of the 4 cases mentioned here, s 138
was relied on unsuccessfully.

Davidson case:
● Rejected argument that in relation to financial matters, Mr Davidson was entitled to rely on managers and
fellow directors under s 138 who were responsible for looking after the financial side of things. Justice
Miller said all directors are expected to have a base level of financial competence.

Oberholster case:
● Claim for breach of duty under s 137 and also reckless trading.
● Dr Oberholster who was 1 of 2 directors in that case. He was relying on the director who turned out to be a
fraud. The other director was the one who was there on the ground running the particular company. Dr
35
 Oberholser would come along, visit the company maybe once a week and ask for information about how
the company is going, are investors' money accounted for etc and would get oral assurances that
everything was fine.
● That was held to be both a breach of s 137 because Dr Oberholster did not do enough to monitor what the
other director was doing, and Dr Oberholster tried to argue - I should be able to rely on s 138 because I
was relying on what the other director was telling me. The Court said you can’t rely on s 138 - that
would be inconsistent with the nature of the duty. If the specific duty is to properly monitor the
performance of the obligation, monitor the other director’s activity, ask for written reports and
financial reports so that you are able to do so, then it would be inconsistent with that duty to be able to
say I was relying on the oral statements from the other director.
● The other point that was made in relation to s 138 was that the Judge said what s 138 contemplates is
proper written documentation. It does not contemplate just oral advice from another person, as
happened in this case where Dr Oberholster just got oral reports from the other director, so when you look
at s 138- it is talking about reports, statements, financial data, the nature of the information although it does
refer to other information - the nature of the kind of thing that are being contemplated here are much more
formal in nature the Judge said that just the informal oral advice that Dr Oberholster was receiving from his
fellow director. You would expect there to be some form of written considered advice or reports if you are
going to rely on s 138.

Morganstern case:
● Primarily a reckless trading case, also breach of s 131.
● The director who had caused the company to enter into an unwise transaction endeavoured to rely on the
advice of a firm of accountants under s 138 (BDO), saying yes I have relied on the advice of these
accountants, and the CA said look there is a number of problems with your argument based on s 138.
● First of all, if you are going to rely on s 138 as a defence - it is an affirmative defence and needs to be
pleaded. You can’t just rock on up at trial and say yeah I am relying on s 138. You need to plead it as a
defence in your statement of defence and that had not been done.
● Second, the onus is on you the director to prove the reliance on the expert advice or whoever you are
relying on under s 138, so that the onus of proof is on the director
● Thirdly, the court will expect the director who is relying on s 138 to call direct evidence at trial from the
advisors in question.
● In this case, BDO were not called. I suspect the reason was because if they had been called they would
have said we were not given all the information - if we were, we never would have given the advice to the
director that we gave if the director had told us that the particular project the company was doing had lost
its resource consent - big issue in that case.
● So BDO the particular advisor had not been called to give evidence, so in those circumstances the
credibility of the argument by the director under s 138 was significantly damaged
○ Same point made in another CA case Mason v Lewis - another reckless trading case where s 138
was relied on, but again the advisors that the directors were seeking to rely on were not called to
give evidence in that case either.

Relevant to duty of care cases - in addition to s 138, is a policy issue which arises out of the purpose behind the
director’s duty provisions in the act, as indicated in the purpose statement in the long title to the act and
discussed by the CA last year in a case called Cooper v Debut Homes.

Long title:
● Back at time the 1993 act was passed, rather than having a separate purpose statement in the Act, which
would probably be the more usual common approach, instead what was quite common in the early 1990s
was to have long title to the act which would set out the particular purpose behind the legislation.

● The long title included among other statements, these statements:

○ (a) to reaffirm the value of the company as a means of achieving economic and social benefits
through . . . the taking of business risks; and
■ So it was recognised that directors as the managers of a company need to be able to take
reasonable business risks.

36
 ○ (b) To encourage efficient and responsible management of companies by allowing directors a wide
discretion in matters of business judgment while at the same time providing protection for
shareholders and creditors against the abuse of management power.
■ So again, it was contemplated that directors would be given a wide discretion in matters of
business judgment - they should not be policed so heavily that the benefits of the
corporate form are lost because directors don’t feel able to take business risks in a
reasonable way.

● These passages in the long title were specifically referred to in the CA’s judgment in Cooper v Debut
Homes, and as being relevant to consideration of how to apply the Director Duties sections in the Act.
○ The discussion in Cooper was more in relation to reckless trading and s 131 rather than s 137, but
think that the proposition applies broadly to the consideration of director duties generally, and
certainly particularly to s 137.

One of the leading cases that deal with the director’s duty of care is the Australian case of Daniels v Anderson.

Daniels v Anderson (discussed in considerable detail in the Watts textbook (494 - 499))
Although it is an Australian case, it is certainly relied on in New Zealand and would be regarded as good law in this
jurisdiction.

Facts:
● The case involved a rogue senior employee Mr Cavell who had been misapplying company funds on
unauthorised foreign exchange dealings, leading to the company incurring a loss of $50 million.
● The company bought a claim against its auditors Deloitte saying you have breached your duty of care to
the company, as you should have been checking the systems of the company and noticing that something
was going wrong here - that would have enabled us to stop Mr Cavell from doing what he was doing.
● The auditors said if the company is going to sue us, we are going to bring in the directors of the company
because the persons predominantly responsible for monitoring Mr Cavell are not us as the auditors, but the
Board of Directors who are responsible for monitoring the management of the company generally, and if
we are liable for breach of duty of care to company, then the directors should indemnify us for that or at
least contribute to the loss as joint tortfeasors. Thus, Deloitte joined as third parties both the CEO Mr
Hooke and all the non-executive directors as well

Held:
● The judgment of the Australian Court deals with the potential liability of the directors in quite some detail
and in the end finds the CEO Mr Hooke to have breached his duty of care to the company, but not the non
executive directors. The different outcomes as between the CEO and the non-executive directors is quite
interesting and it shows that some directors can be liable and others not liable, because in their different
positions they may have access to more or less information which makes them more or less
culpable.

● Mr Hooke had access to a lot more information. As an executive director, he has got access to day to day
information that non-executive directors may not have and therefore they might not be held to be breaching
their duty of care because they did not have the same warning signs.

● In terms of the non-executive directors and why they were not held liable - they had set some limits to
the foreign exchange operations of company staff and had laid down some ground rules, including the
fact that the foreign exchange dealings that the company was doing were really only supposed to be in the
nature of hedging - safeguarding the company against foregn exchange risks. In fact what Mr Cavell was
doing was trying to make profit from foreign exchange dealings as if that was a business line of the
company, which potentially if it went well might make the company a lot of money, but if it didn’t - it
exposes the company to the huge risks which of course came to fruition in this particular case with the $50
mil that was in fact incurred. So the non-executive directors had laid down some ground rules and
expressed also some concerns about some apparent large profits in the foreign exchange
operation, when the operation was only supposed to be a hedging operation safeguarding the company
against business risks. The non-executive directors had called the auditors to a board meeting and
37
 were told that there was nothing to be concerned about. They had also relied on the appointment of a
new senior manager asked to oversee the foreign exchange operations. So in all the circumstances
taking all those matters into account - the non-executive directors had not breached their duty of care to the
company. They had acted appropriately.

● The CEO however had a lot more information. He had received some advice that not all was well in the
foreign exchange operation, that accurate record keeping was not being maintained, he did not report
those facts to the board, the CEO had also received some advice that an outside expert review of the
operations was needed - he did not tell the Board about that either. Mr Hooke the CEO was anxious not to
cause upset to Mr Cavell, because he considered him to be a valuable asset to the company and he did
not really weigh up the benefit of retaining Mr Cavell with the risk of the very large dealings in foreign
exchange entailed.
○ So Mr Hooke was aware that not everything was well, did not share that information with the
Board, and did not make further inquiries when those were clearly necessary given the
information that he had.

,#K&'+4#&')"#&'+#4+*-5&#%"#&'+#2)(&*#*'%=0"1#&')&#)#3-&/#%2#()4+#()"#$+#$4+)('+3#$/#*%<+#304+(&%4*#$-&#"%&#$/#
%&'+4*#0"#&'+#*)<+#2)(&-)5#(04(-<*&)"(+#3+.+"30"1#%"#&'+#3022+4+"&#5+@+5#%2#0"2%4<)&0%"#)"3#F"%=5+31+#&'+/#+)('#
')@+E#&'+#Daniels case is also important and useful because it sets out a number of general propositions by the
Court as to what is required of directors to comply with their duty of care. As have said, that is discussed in quite
some detail in the Watts textbook (494 - 499) - read those pages but some of the key propositions are set out in the
next couple of slides.

Key points from Daniels:

● As a general proposition, and this is consistent with what Justice Miller said in Davidson case - Directors
must understand the nature of the business of the company and the risks to which it is subject
○ That is axiomatic really. Directors have to understand the nature of the business.

● They are expected to understand the company’s financial statements

○ Again, consistent with what Justice Miller said in Davidson.

● They are expected to be able to bring to bear an informed and independent judgment on matters coming to
the board.
○ What if you have 1 director who just is essentially reliant on a very strong CEO or managing
director, and whatever they say they roll with - e.g. Boris is managing director, I am just going to do
whatever Boris says. Well no - you are supposed to inform yourself as to the relevant background
to any decisions, and you are supposed to exercise independent judgment on matters coming to
the board - you don’t just second guess what the managing director what he or she wants, you
form your own independent judgment. Equally - you should not just do what one shareholder tells
you to do.
■ So if directors just defer to the wishes of the CEO - they are not bringing independent
judgment to bear.
■ And if a director just leaves decisions to the other directors - that is also not sufficient.
■ Duty of care extends to watching out for conflict of interest and to ensure that the
company’s interests are being considered - need to push back on any agenda against the
company’s interests.

● Directors must understand what is needed to adequately monitor the actions of management
○ A lot of the breach of duty of care cases involve a failure to monitor management.
○ Oberholster is an example of that. We will come to that case when we get to reckless trading.
○ Both executive and non-executive directors must reach the same general standard of care and
skill, although what they will be expected to know and do will be different (see also Grant v
Johnston at [60]).

38
 ■ Well that is apparent from the result in Daniels. We are applying the same duty of care and
skill to the non-executive directors as we are to Mr Hooke as CEO, but the CEO had more
information, and so he was liable whereas the non-executive directors who did not have
that information were not held liable - were not expected to take any further steps than
what they had already taken.

● Directors are expected to attend all meetings of directors.

● They may not tailor their functions to pre-fixed intervals between meetings and must meet as often as is
necessary. (In closely held companies, however, it may be possible for all directors to know what is going
on without many formal meetings).
○ So there might be a standard for a BOD to meet only once every month, but a crisis arises maybe
the company’s business model has become untenable because of COVID 19 and they have got to
deal with some fundamental issues with the business as a matter of urgency. They are going to
have to meet straight away - they can’t just wait for the next monthly or 2 monthly board meeting.
○ Of course, whether you need a formal board meeting or just more informal interaction with
directors might depend on the nature of company. In closely held companies - they might all be
working together essentially and there might not need to be the formal meetings that you might
expect in a larger company.

● Directors cannot rely unquestionably on the abilities and honesty of their managers.
○ So again - you see that with cases like Daniel v Anderson where Mr Cavell despite the warning
bells was allowed to just carry on and do his substantial foreign exchange dealings by the CEO.
the CEO in that circumstance had an obligation to inquire further.

● Where independent or specialist advice appears necessary, they must seek it

○ If they are not quite sure what to do - maybe there is a question mark as to whether or not a
particular transaction needs commerce commission approval or some other form of regulatory
approval or whether there is going to be an issue with resource management type issue with
acquisition of the particular property - go and get your legal advice on that or expert advice.

Grant and Khov v Johnston (NZCA) (2016):

● Case where claim was made based on alleged breach of director’s duty of care.
● The claim was made against a Mr Johnston who was a non-executive director, and the CA made this
comment;
○ “. . . it is important not to confuse the role of a non-executive director like Mr Johnston with that of a
company’s management. A non-executive director is responsible for exercising a reasonable
degree of skill and care in overseeing the company’s management and control and when
participating in any significant decisions to which the company is a party. He or she is not
responsible for managing the company’s business on a daily basis.”
■ So won’t be expected to know everything that is going on, on a daily basis, but has to
exercise a reasonable degree of care in monitoring management and obviously when the
non-executive director participates at a board level in considering significant transactions,
then they will have to exercise due care and skill.

Section 134:
● Be aware that under s 134, “a director of a company must not act, or agree to the company acting, in a
manner that contravenes this Act or the constitution of the company.”
● This is not a section that has been used a lot in the cases, but is still relevant.

INSOLVENCY DUTIES
Duties of directors in a situation where a company is insolvent or likely to be insolvent.

Insolvency Duties at CL:

39
Duty to Act in Best Interest of Company (s 131)
● There is a large body of case law (which we have already discussed to a degree) that where the company
is insolvent or likely insolvent, the directors in complying with the duty to act in the best interests of the
company under s 131, must take into account the interests of creditors.
○ Sojourner v Robb (NZ CA), Morganstern.

● Breach of these rules cannot be released / ratified or otherwise got around by unanimous shareholder
assent.
○ Sojourner v Robb (NZ CA)
○ Recent overseas authority = Kinsela v Russel (NSW CA); Singularis (UK SC)

● Although that s 131 duty requires directors to take into account the interests of creditors in an insolvency
situation, creditors do not have a direct cause of action. The s 131 duty is still owed to the company, and
has to be enforced by the company - Spies v R (HCA).

● Having said that, if the company is in liquidation, then a creditor can bring a claim to enforce s 131 under s
301. The claim would still be for the benefit of the company - it is still to enforce a duty that is owed to the
company - so the proceeds of the claim will go back to the liquidator for distribution among all of the
creditors unless the court orders otherwise.
○ Example in a case involving an enforcement of section 131 duty for a company that had gone into
liquidation was the DHC v Arnerich case (context of distributions to shareholders). Mr Arnerich
had arranged for a distribution of the proceeds of sale of a business by the company to himself and
associated parties. That was held to be a breach of s 131, one of the creditors or the creditor really
who was affected by that breach was able to bring the claim themselves under s 301 because the
company was already in liquidation. And in fact, liability was imposed for the full amount of the
company’s debt to the creditor in that case, so Mr Arnerich was held to have that full liability.

No Duty to Trade On:

● The cases make it clear that if a company is currently insolvent, there can be no duty on directors to
continue to trade on, even where there are reasonable prospects of the company trading out of insolvency
- Lion Nathan v Lee, Gray v Wilson, Sojourner v Robb.
○ I.e. someone can’t argue that this company had a good chance of trading its way out, you should
have continued to trade on because the creditors would have done better.

● Gray v Wilson - Elias J in the HC specifically rejected an argument that the directors had thrown away
value by ceasing to trade.

● See also comments in Sojourner at [24] - could be no breach in stopping trading.

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*+(&0%"#6V6;#

Specific Provisions Relating to Insolvent Trading (ss 135 and 136)

● Section 135 - Reckless trading
● Section 136 - Duty in relation to obligations

SECTION 135: RECKLESS TRADING

A director of a company must not -
(a) Agree to the business of the company being carried on in a manner likely to create a substantial risk of
serious loss to the company’s creditors; or
(b) Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk
of serious loss to the company’s creditors.

40
,#Oberholster- Not properly monitoring a business can mean that even though a director does not realise that
the business is being carried on in a way that is likely to create risk of serious loss to creditors, that may still be
what is happening and with the directors not properly monitoring the situation, they can be said to be allowing
the business of the company to be carried on in that way.

,#A passive failure by some directors to stop reckless trading by other directors can amount to a breach
(Oberholster).

Test - “Likely to create substantial risk of serious loss to the company’s creditors”
● Early cases took a rather strict approach - e.g. Goatlands v Borrell (2007) - Lang J held the directors
liable as there was at least a 25% chance that the relevant debts would not be paid, a 25% chance being
sufficient in Lang J’s view to lead to this test of likelihood being met.

● The CA’s recent decision in Cooper v Debut Homes suggests that approach was perhaps too strict:
○ “A substantial risk, in the sense of more likely than not, of a significant loss to creditors is required”

● Cooper v Debut Homes has gone on appeal to the SC, the appeal has been heard and we are expecting
judgment soon. It will be interesting to see whether the SC continues to take the perhaps slightly more
lenient approach suggested by the CA in Cooper v Debut Homes.

● This is quite a strict test. It is not necessary to show that the directors appreciated the risk that was created
- earlier CA case of Mason v Lewis (CA).
○ “What is required when the company enters troubled financial waters is a “sober assessment” by
the directors, we would add of an ongoing character, as to the company’s likely future income and
prospects.”

● It is quite a strict test under s 135, but that is ameliorated by the fact that the enforcement of s 135 is
usually under s 301 which applies in the case of a company in liquidation, and s 301 is discretionary as to
the relief granted - Mason v Lewis (CA).
○ “The duty which is imposed by s 135 is one owed by the directors to the company (rather
than to any particular creditors)” - Mason v Lewis. However, a creditor / liquidator can bring a
claim for breach of s 135 under s 301 when the company has gone into liquidation.

○ So to the extent that the strictness of s 135 produces a result that is perhaps too harsh, that can be
ameliorated somewhat by the Court’s discretion as to relief under section 301. Will see in a number
of cases where having calculated what the loss might be said to be due to the breach of section
135, the amount ordered by way of compensation or damages against the director, has often been
reduced quite substantially, sometimes by half or sometimes by more. The Oberholster case was
an example of that.

Legitimate Business Risk Test:

● A number of the recent cases have suggested a “legitimate business risk” test in the application of the rules
in section 135.

● This was first suggested by Justice William Young who is now on the Supreme Court, in South Pacific
Shipping (2004). His Honour suggested it was necessary to ask whether the risks taken by the directors
were “legitimate”: otherwise [it] is impossible to apply the section [135] in a sensible way.”

● That case has been followed in a number of cases including in Re Condrens Parking Ltd (2008), and has
been endorsed by the CA in Cooper v Debut Homes (decision of SC pending).

● Recent cases have suggested that a company need not stop trading as soon as it is technically insolvent.
Business is inherently risky, and directors should be allowed some “margin of appreciation” in the
management of the company’s affairs (Madsen-Ries v Greenhill). The potential upside of the transaction,
must be considered with the potential downside. This is consistent with the long title to the Act, which
41
 suggests that one of the purposes of the legislation is to encourage the efficient and responsible
management of companies and to allow directors a wide discretion in matters of business judgment
(Cooper Davies).

● The courts have suggested that we don’t want to prevent directors from engaging in normal business
risks. That is not what s 135 is intended to do, and the CA in particular relied on the long title to the
Companies Act in supporting that approach, which suggests that it was part of the purpose of the
companies act 1993 to allow a level of discretion to directors and an ability to take business risks.

● Madsen- Ries v Greenhill (2016) NZHC: The Judge in this case suggested you don’t want to take too
strict an approach to the application of s 135.
● “Reckless trading arises when a company’s business is conducted in a manner that is likely to
cause a substantial risk of serious loss to its creditors. A company need not cease trading as
soon as technically insolvent. Most companies struggle at some point, and many go on to
be profitable. Business is inherently risky. To borrow language from another area of law,
directors must be entitled to some margin of appreciation in the way a company’s affairs
are managed. Ex post facto analysis is always easy - making corporate decisions as they arise is
not. However, there is risk and risk. I am satisfied Mr Greenhill’s directorship of Marathon engaged
reckless trading from September 2009 (six months after Marathon became insolvent”).
○ Having said that however, the Judge did then go onto say that Mr Greenhill had been
involved in reckless trading, but nevertheless the passage suggests a degree of discretion
being allowed to directors.

● Cooper v Debut Homes (CA):

○ “In s 135 it is a matter of objectively evaluating that risk. Directors do not become liable under the
section simply because they continue trading after a company becomes insolvent. If directors are
to have a wide discretion in matters of business judgment to encourage efficient and
responsible management of companies as the long title envisages, the bar in terms of risk
to the company's creditors must not be set too high. A court is not to assess the risk of a
particular transaction ignoring up-side to the business. It is a risk and loss to the company as a
whole that is referred to and not just in relation to a particular transaction.”

○ “A substantial risk, in the sense of more likely than not, of a significant loss to creditors is required.
Risk must be considered with the potential advantage of the proposed action to the company and
an assessment of how likely it is that the advantage will be enjoyed. Potential downside must be
considered with potential upside, otherwise the purpose of encouraging efficient and
responsible management of companies and leaving directors a wide discretion in matters of
business judgment will be defeated. The section must be interpreted in light of its purpose.
Consistent with the long title, caution must be exercised to avoid bringing hindsight
judgment to bear in circumstances which do not fully and realistically comprehend the
difficult commercial choices facing the directors.”
■ That “wide discretion in matters of business judgment” is the CA picking up on some of the
language in the long title to the Act.

● A decision to diversify, particularly where there is potential for significant profit, would be a legitimate
business risk.

Cooper v ● The company was in a difficult financial position and the director had to make a difficult
Debut Homes decision whether the company should continue to finish the building of certain
(CA) properties that it was engaged in the development of, or should it close things down.
And the potential upside from profit of completing those transactions was quite significant,
and the director considered it outweighed the risk of continuing with those property
developments. And the CA thought that was a reasonable decision. That has gone on appeal
to the SC. The HC had taken a stricter approach - found director liable. CA said no - that was
a reasonable approach.

42
 ● In conclusion, the CA said - not a breach of s 135, legitimate business risk consistent with the
legitimate business risk test taken in the South Pacific Shipping case.
○ “It seems to us that the decision to complete the houses was a perfectly
sensible business decision. Overall it was likely to improve the return rather
than cause loss to the company’s creditors. It is true that one creditor, the IRD,
would be more at risk than the secured creditors in that there was no specific
provision for the payment of the GST. However, given that there was a sincere belief
that significant surpluses excluding GST were expected overall when all sales had
been completed, and that in due course the GST issues would be able to be
resolved with the IRD to its satisfaction, we are not satisfied that this was reckless
trading. The IRD was at serious risk of getting no GST before the complained of
conduct. The risk taken was legitimate.”

(i.e. applying legitimate business risk test, there was no breach of s 135)

Oberholster ● Decision to agree to funds being transferred from FXCH fund to South African fund which
then collapsed, was a legitimate business decision. There was no evidence that it was
associated with Mr Hitchinson’s fraud. Although in hindsight it was a bad decision, objectively
Dr Oberholster in agreeing to the decision did not agree to allow the company’s business to
be carried on in a way that was likely to cause substantial risk of serious loss to creditors.

“Agree or allow”
● Where a director takes no steps to monitor matters, that may mean he or she has allowed the company to
trade in breach of s 135: Oberholster; Mason v Lewis
○ “Directors must take reasonable steps to put themselves in a position not only to guide, but to monitor
the management of a company. The days of sleeping directors with merely an investment interest are
long gone” - Mason v Lewis

● Both Mason v Lewis and Oberholster involved reckless trading by directors under s 135 that was held to
exist through a failure to monitor the activities of others which turned out to be fraudulent. Therefore, in
both cases, the directors being sued were not actually the ones who had engaged in the fraudulent activity.
○ Of course if you engage in fraudulent activity yourself, can see how that would clearly be a breach
of s 131 and s 135. Therefore, these judgments show that you can liable under s 135 because you
have allowed the affairs of the company to be carried on in a way that creates a substantial risk of
serious loss to the company’s creditors through fraud / misappropriation.

● Oberholster - Dr Oberholster was held to have allowed the company to trade in breach of s 135 because
he had not sufficiently monitored the actions of his fellow director Mr Hitchinson, by ensuring that he Dr
Oberholster received regular financial reports so as to be able to monitor and assess what Mr Hitchinson
was doing.

“Business of the company”

● You have to agree / allow / cause the business of the company to be carried on in a certain way.
● This can include the initial setting up of the company (Re Wait Investments)
● So before the business has really started but you are entering into some initial transactions - like entering
into a long term expensive lease without having the financial capability to do so - that sort of conduct was
held to be a breach of s 135 in the case of Re Wait Investments.

Actions on the close-down of a business?

● DHC v Arnerich - you had the distribution of the proceeds from the sale of the business assets, on the
close-down of the business. Could that be said to be reckless trading even though there is no ongoing
business?
● S 135 reckless trading was not argued in DHC v Arnerich - the liability imposed on the directors was under
s 131 for failing to take into account the interests of creditors.
● However, it is perhaps arguable that this amounted to agreeing or allowing the business of the company to
be carried on in a way that was likely to create substantial risk of serious loss to the company’s creditors.
43
Quantum of Damages for breach of s 135:
● Mason v Lewis (CA) sets out the normally accepted starting point for the assessment of damages for
breach of s 135.

● This is based on the net worsening or deterioration of the company’s position through trading on -
the difference in the financial position of the company between “the time that inadequate corporate
governance became evident (really the “breach” date”’ (when the company first engaged in reckless trading
/ should have stopped trading), and the date when the company went into liquidation, or when the directors
resigned if the directors resigned before the company went into liquidation.
○ If the directors should have stopped trading on 1 Jan when the net deficit of liabilities over assets
was say $3 million, and then the company did not go into liquidation until 6 months later, and by
that time the net deficit had increased to $6 mil, then the starting point for damages would be the
difference between those 2 figures (i.e. $3 mil), subject to some discretion and considerations
which we will talk about shortly.

● Normal reckless trading cases are brought by a liquidator (sometimes by a creditor) after the company has
gone into liquidation, and are therefore brought under s 301 of the Act. Awards under s 301 are
discretionary.
○ “Once that figure has been ascertained, the New Zealand Courts have seen three factors -
causation, culpability [moral blameworthiness], and the duration of trading - as being
distinctly relevant to the exercise of the Court’s discretion” - Mason v Lewis.

● In some cases such as Oberholster, there was quite a substantial reduction (around 50%) was made to
the starting point in terms of the actual damages awarded in the case.

SECTION 136: DUTY IN RELATION TO OBLIGATIONS:

S 136 is a companion section to S 135.
● “A director of a company must not agree to the company incurring an obligation unless the director
believes at that time on reasonable grounds that the company will be able to perform the obligation
when it is required to do so.”

Application of s 136:
● Requires that the directors have BOTH an honest belief that the company will be able to meet its debts
when they fall due, and secondly that there must be reasonable grounds for that belief.
○ Subjective belief of ability to pay; and
○ Objective test of whether there are reasonable grounds to justify that belief.

● Madsen-Ries (2016): “A company need not cease trading as soon as technically insolvent. Most
companies struggle at some point, and many go on to be profitable.”

● Breach of s 136 may be harder to establish than s 135.

○ A number of reckless trading cases that have succeeded under s 135 have not succeeded under s
136 - e.g. Oberholster case and the Mainzeal case - the directors were held liable under s 135
but not under s 136.
○ Mainzeal has gone to the CA, but we do not have a CA judgment yet.

● One example that gives rise to a risk under s 136, is a small company guaranteeing the debts of a large
company (unless guarantee limited in amount). The small company is essentially putting itself on the line
for the guaranteeing the debts of the large company. Can the directors of the small company honestly say
that they have a belief on reasonable grounds that the small company is going to be able to meet its debts
going forward as they fall due? Potentially gives rise to a risk under s 136.

FXHT Fund Managers (in liq) v Oberholster (2009)

44
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Facts:
● Company FXCH Funds Managers managed private foreign investments in exchange markets. The
company had 2 directors - Mr Hitchinson and Dr Oberholster.
○ Dr Oberholster was held liable for reckless trading under s 135, even though the real cause of the
company’s problems was Mr Hitchinson’s fraudulent actions in misappropriating money of the
company.

● Mr Hitchinson was an executive director and employee of the company as a fund manager. He made all
the day to day management decisions in relation to funds.

● Dr Oberholster was a non-executive director. He visited the business premises about once a week and
asked Mr Hitchinson about the status of the company, whether it was making a profit and whether all
investor funds were accounted for. Dr Oberholster received positive oral responses from Mr Hitchinson that
everything was fine.

● Investor funds had initially been invested in the FXCH Fund. This platform was performing quite badly and
so the company made a decision to withdraw the funds and transfer them across to the South African FX
Active Fund. The recommendation of that change was made by Mr Hitchinson and a trader employee Mr
Duplessis - the people on the ground who understood what was going on in the markets. Dr Oberholster
agreed to this change on their recommendation. This was one issue that gave rise to some problems,
because later on the South African fund collapsed and the investors lost their money.

● The second problem was that unbeknown to Dr Oberholster, Mr Hitchinson was misappropriating investor
funds.

● The company ultimately went into liquidation, the liquidator brought a number of causes of action against
Mr Oberholster, including breach of duty of care, s 135 and s 136.
○ Mr Hitchinson has gone - does not have the funds to be able to pay back any of the losses that the
company has suffered. And so the liquidators are looking around for a potential easy target that
might enable the creditors of the company to be paid back some or all of their investment.

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50)$050&/#20"30"1*#%2#&'+#PG#=+4+#(')55+"1+3;#

S 136 Claim: [NO LIABILITY]

● In terms of s 136, the question is whether Dr Oberholster agreed to the company incurring obligations at a
time when he did not believe that the company would be able to pay those obligations in terms of test
under s 136.

● Here, the obligations incurred were the obligations to repay investor monies. The investors ended up losing
their money for 2 reasons:
○ 1) Because of the failure of the South african FX active fund; and
○ 2) Because of Mr Hitchinson’s misappropriation or theft.

● Neither of those 2 events were known to Dr Oberholster at the time that he agreed to the company
incurring the obligations to investors by accepting the money in by investors. So at the time that Dr
Oberholster knew that the moneys were being received, he had no reason to believe that the
company FXHT would not be able to obtain back the client funds from the FX Funds that the
moneys had been put into, and paid them back to the investors if required to do so.

45
 ● Therefore, Dr Oberholster did have an honest belief on reasonable grounds that the company would be
able to meet its obligations as they fell due. Thus, the case under s 136 was not made out.

S 135 Claim: [LIABILITY ON 1 ARGUMENT]

1) Allowing Mr Hitchinson’s misappropriation of assets
● The first argument based on breach of s 135 succeeded under the second limb of s 135, that in failing to
properly monitor his fellow director Mr Hitchinson, Dr Oberholster had allowed the business of the company
to be carried on in a way that was likely to create substantial risk of serious loss to creditors through
misappropriation.

● There was no business plan or budget. Dr Oberholster never saw monthly reports or financial statements -
he essentially just left the running of the business to Mr Hitchinson. Mr Hitchinson had sole signing
authority on the company’s cheque account. Thus by not having proper controls / monitoring system /
monthly financial statements, Dr Oberholster was not really in a position to know what was going
on. He was thereby putting Mr Hitchinson in a position where his misappropriation could easily
occur, not be picked up, and that was allowing the business of the company to be carried on in a way
that was likely to cause a substantial risk of loss to the company’s creditors through misappropriation.

● The fact that Dr Oberholster did not have any prior reason to question Mr Hitchinson’s integrity,
was not relevant. The fact was that by not having those controls in place - not properly monitoring or
enabling the proper monitoring of Mr Hitchinson, was allowing the company’s business to be carried on in a
way that was likely to cause a real risk of serious loss to the creditors.

● The test is not whether Dr Oberholster had reason to doubt Mr Hitchinson, but rather, whether Dr
Oberholster caused or allowed the company to be carried on in a manner which was likely to allow Mr
Hitchinson to defraud investors. To allow an executive director free rein over the control of a
company, which has as its business the investment of clients’ funds, could readily be understood
to create a substantial risk of serious loss to those investors through fraud or misapplication of
money. While Dr Oberholster may have asked all the right questions, there was no basis upon
which he could test the answers Mr Hitchinson provided.
○ So if he had insisted on monthly financial reports, and had put controls over who had signing
authority etc, there might have been an opportunity to check the answers Mr H was giving him
when in those weekly meetings Dr Oberholster was asking how things were going. He was getting
the right assurances from Mr Hitchinson, but he was in no position to check whether those
assurances were honest or correct.

● As the test is objective it can make no difference when determining liability under s 135 that Dr
Oberholster was innocent and unaware of Mr Hitchinson’s fraud. The question is what the reasonably
prudent director in Dr Oberholster’s shoes would have done. Mr Hitchinson was able to carry out his
fraudulent activity because he was left to run the business of the company without sufficient
control by Dr Oberholster.

● I conclude that by allowing Mr Hitchinson to operate the business without adequate supervision, and by
failing to ensure proper reporting systems (even monthly profit / loss and cashflow reports) were put in
place, Dr Oberholster caused or allowed the business of FXHT Fund Managers to be carried on in a
manner likely to create a substantial risk of serious loss to the company’s creditors.

2) Agreeing to transfer funds to South African fund

● The second argument based on breach of s 135 was that in agreeing to the client funds being transferred
to the South African FX fund which then collapsed, Dr Oberholster had agreed to the business of the
company being carried on in a way that was likely to cause substantial risk of serious loss to the company’s
creditors. If this argument succeed, it would have increased the quantum of loss that would have been
claimable by Dr Oberholster by the liquidator.

46
 ● However, this decision by itself was not considered to be reckless in terms of s 135. It was considered to
fall within the legitimate business risk type approach.

● Justice Venning discusses this at [80], talking about the previous judgment of William Young in the Re
South Pacific case:
○ “In Re South Pacific Shipping Limited, William Young J made a distinction between the taking of
legitimate business risks. The approach was confirmed on appeal. The decision to transfer from
the FXCH trading platform to FX Active was a legitimate business decision. There is no
evidence that it was in some way associated with Mr Hitchinson’s alleged frauds. With the benefit
of hindsight it was a bad decision but, in agreeing to the change, Dr Oberholster was not
objectively agreeing to the company’s business being carried on in a manner likely to
create a substantial risk of serious loss.
■ Clearly the first fund was not performing well - something needed to be done.

Mason v Lewis: (CA):

● [51] “The essential pillars of the present section are as follows:
○ The duty which is imposed by s 135 is one owed by the directors to the company (rather than to
any particular creditors).
○ The test is an objective one;
○ It focuses not on a director’s belief, but rather on the manner in which the company’s business is
carried on, and whether that modus operandi creates a substantial risk of serious loss; and
○ What is required when the company enters troubled financial waters is a “sober
assessment” by the directors, we would add of an ongoing character, as to the company’s
likely future income and prospects.”

● “We observe it is important not to conflate the provisions of s 135 [breach section] and s 301 of the
Companies Act when determining the liability issue. The issues are twofold: should there be liability
[determined pursuant to the test under s 135], then, what is the appropriate relief?” [that is where the
discretion under s 301 becomes relevant]

● The CA rejected an argument from Salmon J at first instance that there was a subjective element as an
overlay to s 135. The CA said that as a matter of statutory construction, s 135 does not contain or even hint
at, any limitation of the kind suggested by Salmon J on the section. Therefore, directors do not
necessarily need to appreciate the risk.
○ Note that the “legitimate business risk test” read in by the subsequent cases is not provided for by
s 135 either. However, what the Courts have said, including the CA in Cooper v Debut Homes, is
that you have got to apply s 135 consistent with its purposes and the Long Title, and the legitimate
business risk test is the way that the long title’s purposes is adhered to.

● [83] “Directors must take reasonable steps to put themselves in a position not only to guide, but to
monitor the management of a company. The days of sleeping directors with merely an investment
interest are long gone.”
○ Mason v Lewis and Oberholster - are both cases involving reckless trading being held to exist through
a failure to monitor fraudulent activities of someone else, so that the director or directors being sued
were not actually the ones who had engaged in that fraudulent activity. Of course if you engage in
fraudulent activity yourself you could see how easily that could be held to be a breach of duty, not just
section 131, but also of s 135, but here we are imposing a duty on the directors for failing to monitor
those other persons who have been fraudulent, and so both of these judgments show that the test in s
135 can be held to exist just because you have allowed the affairs of a company to be carried on in a
way that creates a substantial risk of serious loss to the company’s creditors.

● In addition to liability for reckless trading under s 135, the directors in Mason v Lewis were also held liable
under s 300. This section provides that where a company does not comply with the requirements for
proper financial records and that failure / breach contributes to the company’s insolvent position,
the Court has a discretion to impose personal liability on the directors for all or part of the debts of the
company.
47
 ○ Importantly, S 300 creates a new liability for inadequate records This is different to s 301, which
does not create any new liability, but rather just enables a liquidator or creditor to enforce existing
breaches of duty such as s 131, s 135, s 136, s 137.

○ “Section 300 is important in its own right. It works in tandem with s 135; a director cannot be heard
to say “I did not realise we were in such a pickle, because we did not have any, or adequate, books
of account.” It is fundamental that such books must be kept and directors must see to it that they
are kept.
■ In this case in Mason v Lewis, the proper financial records had not been kept, that had
contributed to the company’s poor financial position and the directors were held liable
under section 300, in addition to under section 135.

Section 300(1) and (2): Section 300 was discussed in Mason v Lewis which gives rise to liability on directors in a
case where the company has not kept proper financial records and that has contributed to the company’s poor financial
position.

(1) Subject to subsection (2), if -

(a) A company that is in liquidation and is unable to pay all its debts has failed to comply with -
(i) Section 194 (which relates to the keeping of accounting records); or
(ii) Section 201 or 202 (which relates to the preparation of financial statements or group financial
statements) or any other enactment that requires the company to prepare financial
statements or group financial statements; and
(b) The considers that -
(i) The failure to comply has contributed to the company’s inability to pay all its debts, or has
resulted in substantial uncertainty as to the assets and liabilities of the company, or has
substantially impeded the orderly liquidation; or
(ii) For any other reason it is proper to make a declaration under this section , -

The Court, on the application of the liquidator, may if it thinks it proper to do so, declare that any 1 or more of the
directors and former directors of the company is, or are, personally responsible, without limitation of liability, for all or
any part of the debts and other liabilities of the company as the court may direct.

(2) The court must not make a declaration under subsection (1) in relation to a person if the court considers that
the person -
(a) Took all reasonable steps to secure compliance by the company with the applicable provision referred
to in paragraph (a) of that subsection; or
(b) Had reasonable grounds to believe and did believe that a competent and reliable person was charged
with the duty of seeing that that provision was complied with and was in a position to discharge that
duty.

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Mainzeal Property and Construction Ltd: (NZHC) (2019):

Won’t spend much time on this case. The case has gone on appeal to the CA. The liability may well be there, but
the quantum of $36 million in damages awarded by Justice Cook of the HC (huge sum) against the directors, is
unlikely to be justified on the basis on which it was awarded.
● There was no loss on the Mason v Lewis approach, and the Judge invented a new approach for the
starting point of damages (total amount of loss to creditors) that was not pleaded.

Facts:
● Mainzeal was a construction company - largely owned by Richina Pacific (parent company overseas).

48
 ● Mr Yan was a very much a Richina person, and was largely in control of Mainzeal, but there were these
independent directors as well including Dame Jenny Shipley (former PM), and Mr Gomm and Mr Tilby.
These directors were all sued for having engaged in reckless trading.
● Justice Cook found the directors liable under s 135 but not under s 136.

Breach of s 135
There are three key considerations that cumulatively lead me to conclude that the duties in s 135 were breached:
● (a) Mainzeal was trading while balance sheet insolvent because the intercompany debt was not in
reality recoverable
○ So there was money owing by other companies in the Richina pacific group to Mainzeal, but that
was not in reality recoverable - the main company that owed the money did not have the ability or
the assets to pay that.
● (b) There was no assurance of group support on which the directors could reasonably rely if adverse
circumstances arose
○ So there was a letter which had been provided to the company’s auditors from Richina pacific
saying it was standing behind Mainzeal, but that letter was not legally binding. So there was no
assurance of group support that the directors could reasonably rely on.
● (c) Mainzeal’s financial trading performance was generally poor and prone to significant one-off losses,
which meant it had to rely on a strong capital base or equivalent backing to avoid collapse.

No Breach of s 136:
Section 135 was held to be breached, but s 136 was not. This was partly a pleading in evidence problem.
● Justice Cook took quite a strict approach to s 136 - you have to look at the particular obligations that
were said to be entered into without reasonable belief that the obligations would be met as they fell
due. So what were Mainzeal’s obligations? Obligations under different construction contracts.

● Justice Cooke said well - the particular obligations arising from the construction contracts were not put to
the directors on cross-examination, and the nature and extent of the obligations under the construction
contracts not was not specifically put in evidence.
○ So there was simply a failure to establish the evidence for the case under section 136.

● [309] “My expectation is that, even if the nature of the obligations had been clearly established, it is unlikely
that a breach of s 136 would have been established. No doubt, the obligations involved in those contracts
contemplated Mainzeal performing them for a reasonably significant period of time. But there is no
reason to conclude that the directors either did not believe that those obligations would be fulfilled,
or to conclude that the reasons for believing they would be fulfilled were unreasonable. Whilst the
directors exposed the creditors to a substantial risk of serious loss [i.e. while there was a breach under s
135], it would not have been apparent to the directors that Mainzeal’s failure would occur, or would likely
occur immediately, or within a particular period of time, at least until very near to the point when Mainzeal
failed. That seems to be critical to establish liability under s 136 in these circumstances.”

Assessment of Quantum:
● The liquidator’s case against the directors was pleaded on a Mason v Lewis basis
○ i.e. starting point is the diminution of assets between the date the company should have stopped
trading, and the date the company went into liquidation. The directors should be liable for that
amount, subject to the court’s discretion.

● However, there was NO LOSS the Mason v Lewis basis

○ [538] “The ultimate conclusion is that the creditors were better off than they would have been had
there been an earlier liquidation. There would accordingly have been no loss arising from the
breach on this [Mason v Lewis] approach.”
■ Diminution of the assets of the company was negative $514,000 (i.e. no loss)

● Justice Cook of the HC then developed a new approach that was not pleaded, and set the starting point as
the total amount owing to creditors of $110 million.
49
 ○ [427] “. . . the starting point for the assessment of the amount to be awarded under s 301 is the
entire amount of the deficiency in liquidation - here assessed at $110,646,126.” (emphasis added).

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● Very real natural justice issues involved in that. So wonder whether the quantum judgment really
ought to be supportable on that basis. But will see what the CA has to say about that.

Single Transaction Breaches of s 135:

Most reckless trading cases involve carrying on business for a period of time when the business was clearly
insolvent - i.e. general trading amounting to reckless trading. However, there can be cases where a single really
really bad / unwise transaction can be considered to amount to reckless trading in itself.

Morganstern Not going to spend a lot of time on case - just an example of breach for a single transaction.
v Jeffreys
[2014] NZCA Facts:
● The transaction in this case was Mr Morganstern selling his shares in one company (MS St
Lukes) to MSE, of which he was a director as well. The price was $3.5 million, even
though the company was not worth anything like that, or perhaps anything.
● Clearly very unwise transaction - causing the company which he was a director of, to fork out
$3.5 mil. Some of that was going to be left as a debt owing to Mr Morganstern, but some of it
was a discharge of a current account debt that Mr Morganstern had to Morning Star
Enterprises.
● This single very unwise transaction, certainly from MSE’s perspective, was held by
itself to amount to reckless trading in breach of s 135, because it was agreeing to the
business of the company MSE being carried on in a manner likely to create substantial risk
of serious loss to the company’s creditors, because MSE was partying with a substantial
asset and replacing it with shares in a company that turned out to be essentially
valueless.

COVID 19 Changes to S 135 and S 136:

For a number of companies the impact is hopefully temporary - substantial liquidity impacts as sales and revenues
are down substantially, certainly during lockdown period but for some time to come. Tourism sector - the impact
might be for several years and the hospitality sector - might be more a matter of weeks or months. There may be
businesses in between that. What parliament has done is pass some provisions which essentially are trying to give
the directors some leeway so that in the short term where their companies are suffering serious liquidity
problems because of the impact of COVID 19 but long term the businesses are sound, then the fact they
are continuing to operate the businesses should not be taken to be a breach of s 135 and s 136.

Covid-19 Response (Further Management Measures) Legislation Act 2020:

● Given royal assent on 15 May 2020 - now in force and includes new schedule 12 to the CA 1993 which
impacts on the insolvency duties (s 136 and s 136).

● Intended to provide some protection against impact of reckless trading prohibitions to directors for actions
between 3 April 2020 and 30 September 2020
○ So for that period of time - if directors enter into obligations or carry on business of the company,
their actions will not be taken to breach s135 or s 136 in certain circumstances.

● And it is in circumstances where companies have temporary liquidity problems due to the impact of COVID
19.

50
Purpose of temporary measures:
● As this Bill came close to passing, a Supplementary Order paper was introduced at almost the last minute
on the 12th of May - setting out some purpose provisions in clause 1(a). So the way the legislation has
been introduced - as a new schedule 12.

● “The purpose of this schedule is to give to directors of companies that are facing significant liquidity
problems because of the effects of the outbreak of COVID 19 more certainty about their duties when -
○ (a) agreeing to the business of the company being carried on or causing or allowing the business
of the company to be carried on; and [reflects the words of s 135]
○ (b) agreeing to the company incurring obligations. [reflects wording of s 136]
■ Clause 1AA(1) Schedule 12.

● “However, it is not a purpose of this schedule to facilitate the ability of a company that has no realistic
prospect of continuing to trade or operate in the medium or long term to defer a decision to enter into
liquidation to the detriment of its creditors.”
○ Clause 1AA(2), Sch 12.

● Thus, this legislation is aimed at companies which have a temporary liquidity problem but have
reasonable medium or long term prospects - it is to give them some protection in the meantime. But if
the impact of COVID 19 on the business is so significant and long term that the company really has no
realistic prospect of continuing to trade in the medium to long term, then this legislation is not supposed
to stop directors from biting the bullet and calling it quits.

Safe Harbour Provisions:

1) Who do the provisions apply to?
The legislation introduces safe harbour provisions. These provisions apply only to certain companies:

● A company that was already incorporated at the start of this year, but as at 31 December 2019 was “able
to pay its debts as they became due in the normal course of business” or;
○ i.e. if company was already insolvent at the start of this year, this legislation will not help you

● A company incorporated between 1 January 2020 and 2 April 2020 (inclusive)

● NOT companies incorporated on or after 3 April 2020 / banks / insurers / non bank deposit takers

2) Burden of proof:

● Burden of proof on the person who wants to rely on the safe harbour provision (see cl 7 of Sch 12).

3) Safe Harbour Period:

● The safe harbour period is 3 April 2020 to 30 September 2020.

○ We are talking about actions of directors during this period - entering into obligations during this
period, or carrying on / allowing the carrying on of the business during this period.

● If the actions of the directors that are being challenged are before the 3 April or after the 30 September this
year, they are not going to be covered by the provision, subject only there is provision in this safe harbour
period to be extended by regulation.
○ If the Govt feels that the impact of COVID 19 is significant and ongoing, then this period might be
extended.

Section 135 safe harbour (cl 5 of new sch 12):

● Applies to director agreeing to carry on business (or allowing it to be carried on) during the safe harbour
period (3 April - 30 Sept 2020)

51
Subsection (2): The actions of the director do not breach section 135 if at the time of taking them, the director, in
good faith, is of the opinion that -
● (a) the company, has, or in the next 6 months is likely to have, significant liquidity problems; and

● (b) the liquidity problems are, or will be, a result of the effects of COVID-19 on the company, its debtors
or its creditors; and
○ E.g. perhaps the company’s debtors have not been able to pay the company because of the
effects of COVID 19, or maybe the creditors need to make demand more quickly b/c they are in
urgent cash flow position.

● (c) it is more likely than not (see test in cl 5(4)) that the company will be able to pay its due debts on and
after [30 September 2021*]
○ In other words, current liquidity problems but it looks like after another year’s time, that the
company’s prospects are good after that period. So we are not talking about companies that are
wiped out by this.

Clause 5(4) Test: For the purposes of the opinion required by subclause (2)(c), the director may have regard to -
● (a) the likelihood of trading conditions improving;
○ That would be specifically focused on the particular industry involved. Tourism - what are the
chances the trading conditions will improve during that period? Might be more problematic than
other industries perhaps.
● (b) the likelihood of the company reaching a compromise or other arrangement with its creditors;
● (c) any other matters the director considers to be relevant.

Section 136 Safe Harbour (Cl 6, Sch 12):

● S 136 - director of a company must not agree to the company incurring an obligation unless the director
believes at the time that the company will be able to perform the obligation when required to do so.

● Cl 6 provides some potential relief from liability under that section. The relief only applies to obligations
incurred during the safe harbour period - cl 6(3)

● Cl 6(1) provides:
○ “Subsection (2) applies to a director of a company -
■ (a) who, during a safe harbour period, agrees to the company incurring an obligation; and
■ (b) who, at the time of agreeing to the company incurring the obligation, is in good faith, of
the opinion that the company has, or is likely to have, significant liquidity problems.”

● Cl 6(2): [most significant]

● (2) For the purpose of section 136, the director has reasonable grounds to believe that the
company will be able to perform the obligation when it is required to do if the director, in good
faith, is of the opinion that -
○ (a) the liquidity problems are, or will be, a result of the effects of COVID 19 on the
company, its debtors or its creditors; and
○ (b) it is more likely than not (see test in cl 6(5)) that the company will be able to pay its due
debts on and after [30 September 2021*]
■ *Date can be extended by regulation .

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$4+)('+3#*#6V8;!"#)**+**0"1#='+&'+4#&'+#(%<.)"/#')*#4+)*%")$5+#14%-"3*#&%#2%4<#&'+#@0+=#&')&#&'+#(%<.)"/#=055#
$+#50F+5/#&%#$+#)$5+#&%#.)/#0&*#3+$&*#)2&+4#V[#A+.&E#&'+"#=+#5%%F#)&#&'+#&+*&#0"#(5#89b:#

Cl 6(5): For the purpose of the opinion required by subclause (2)(b), the director may have regard to -
● (a) the likelihood of trading conditions improving
52
 ● (b) the likelihood of the company reaching a compromise or other arrangement with its creditors
● (c) any other matters the director considers to be relevant.

NOTE: You get a problem question in exam involving reckless trading. Have a look at the dates involved in the
question and whether or not the dates apply during this safe harbour period because that might impact on the way
in which you would analyse the situation. You would take into account the safe harbour provisions under
temporary sch 12 rather than just the normal rules relating to reckless trading under s 135 and s 136.

Phoenix Companies:

● Phoenix company: New company which has taken over the business of an old company that has gone
into liquidation. You might say that the new company has arisen out of the ashes of the old company.
○ A couple of potential liability issues arise.

● S 131: Firstly, if you are involved in the setting up of this phoenix company and you transfer the assets of
the old company to the new (phoenix) company at less than the true value of those assets, then that can
give rise to breach of duty to the old company under s 131 of the CA 1993.
○ Sojourner v Robb is the prime example of that.

● Phoenix company statutory regime:

○ The second issue that can arise in relation to phoenix companies is that the directors of the new
company (phoenix company) can be held personally liable for the debts of that new company,
where the new company uses the same or a similar name to the old company under the
statutory regime in the Companies Act - in particular s 386C.
○ It is also potentially an offence - can go to prison for up to 5 years.
○ So it is a potentially very important serious part of the Companies Act.

Phoenix Companies - Breach of Section 131:

● If a director transfers the assets of the old company to the phoenix company at an undervalue, that will
amount to a breach of your duty to the old company under s 131.
○ This was the fact pattern in Sojourner v Robb.

● In Sojourner v Robb, the directors (the Robbs) realising that Aeromarine 1 was in difficulty because of its
contracts with Hiscock and Sojourner, caused the company to sell its assets to Aeromarine 2. Aeromarine
2 continued essentially the same business, same staff, same customers, but the sale of the business
assets from Aeromarine 1 to 2 was held to be at undervalue - did not include anything for goodwill. As a
consequence of that, the Robbs as directors of Aeromarine 1 were held to be in breach of their s 131 duty
to act in the best interests of the company, remembering of course that duty takes into account the
interests of creditors in a situation where the company is insolvent or likely insolvent, as we have
also seen from cases such as Sequana.
○ That is one issue to be aware of in a phoenix company situation, Aeromarine 2 being the phoenix
company.

● Also consider s 138A - offence provision for s 131

Phoenix Company Provisions - ss 386A - 386F

● Derived from Uk insolvency legislation.
● Function:
○ To prevent the use of phoenix company name which might potentially confuse creditors of the new
company who think they are dealing with the old company.
○ Deny directors and shareholders advantages from using company name of company that they
presumably have not run well enough to stay solvent - it has gone into liquidation and now they are
using the same company name again and potentially risking a second set of creditors.

53
Section 386A:
(1) Except with the permission of the court or unless one of the exceptions in 386D to 386F, a director of a
failed company [i.e. a company that has gone into liquidation] must not, for a period of 5 years after the
date of commencement of the liquidation of the failed company -
(a) Be a director of a phoenix company; or
(b) Directly or indirectly be concerned in or take part in the promotion, formation or management of
a phoenix company; or
(c) Directly or indirectly be concerned in or take part in the carrying on of a business that has the
same name as the failed company’s pre-liquidation name or a similar name.
(i) That might not necessarily be a company, might be a limited partnership or some other
form of entity that carries on a business with the same name as the failed company’s pre
liquidation name or a similar name.

Section 386B definitions:

● “Phoenix company” means, in relation to a failed company, a company that, at any time before, or within
5 years after, the commencement of liquidation of the failed company, is known by a name that is also a
pre-liquidation name of the failed company or of a similar name.

● “Similar name” means a name so similar to a pre-liquidation name of a failed company as to suggest an
association with that company.

○ Mummery LJ in Ricketts - “It is necessary to make a comparison of the names of the two
companies in the context of all of the circumstances in which they were actually used or likely
to be used: the types of product dealt in, the locations of the business, the types of
customers dealing with the companies and those involved in the operation of the two
companies.” [22]

○ You have got to look at all of that context. Were the 2 companies dealing in the same type of
product? If you think back to Sojourner v Robb - The companies Aeromarine 1 and 2 essentially
had the same name, were both boat building companies. Location of the business - both set up at
the same location. Types of customers / dealings with customers - same. Those involved with the
operation of the companies - had the same staff. You take all of those facts into account in
deciding whether in that context the names are sufficiently similar as to suggest an association
between the two companies.
■ Clearly, the names of the companies were so similar as to suggest an association with the
company that had gone into liquidation (Aeromarine 1). This legislation was not in place at
the time the case occurred, but you could see that this liquidation would have been
applicable to that situation - the Robbs in being directors and managers of Aeromarine 2
would have been in breach of these provisions, because Aeromarine 2 would have been a
phoenix company within the definition - a company with a very similar name to Aeromarine
1 which has just gone into liquidation.

Consequences of breaching section 386A:

● Contravention of s 386A is an offence (up to 5 years in jail or fine of up to $200,000) - s 386A(2).

● Also under s 386C(1), a director contravening s 386A(1)(a) or (b) will be personally liable for all of the
relevant debts of the phoenix company (the new company)
○ This legislation works quite differently from the way the s 131 principles worked in Sojourner. If
think back to facts, the Robbs were liable to Aeromarine 1 (the old company) for having caused the
company to sell its assets at undervalue, but now what these phoenix companies provisions under
s 386A onwards do, is if the facts of Sojourner v Robb happened now, would have created a
personal liability of the Robbs in respect of the debts of Aeromarine 2, as a separate and stand
alone liability to the liability that they might have had under s 131 as directors of Aeromarine
1. They would be liable for the relevant debts of the phoenix company - Aeromarine 2.

54
 ● Relevant debts = debts and liabilities incurred by the phoenix company during the period when the person
liable was involved in its management and the phoenix company was known by a pre-liquidation name of
the failed company or a similar name.
○ So during the period while the Robbs were involved in the management of Aeromarine 2, and
Aeromarine 2 was known by the name of Aeromarine 1 or a similar name.

Exception: (Companies within a group)

● There is an exception to the legislation where the phoenix company was already in existence and non-
dormant for a period of at least 12 months before the failed company entered into liquidation - s 386F
○ This is necessary exception where you have groups of companies - e.g. If got a whole raft of
Telecom companies, they all have similar names because part of the same group of companiesE#
&'+/#<01'&#$+#0"@%5@+3#0"#3022+4+"&#)*.+(&*#%2#&'+#$-*0"+**E#)"3#&'+"#<)/$+#a-*&#%"+#%2#&'%*+#
(%<.)"0+*#1%+*#0"&%#50X-03)&0%"E#)"3#&'+#%&'+4#(%<.)"0+*#0"#&'+#14%-.#=0&'#)#*0<05)4#")<+#
(%"&0"-+#%"#,#&')&#=%-53#"%&#$+#)#.4%$5+<#-"3+4#&'0*#5+10*5)&0%";#

EXAMPLE = Compass Roofing prosecution:

Very recent prosecution involving a number of companies trading as Compass Roofing. The decision on this
penalty - ordering that Sam Spence go to jail for 5.5 years for breach of a number of offences including under the
phoenix company legislation.

Facts:
● Sam Spence was the leading person behind the Compass Roofing business.
● The pattern between 2011 to 2020 was that as each company became insolvent, Mr Spence would
arrange for the sale of the company’s assets at an undervalue to a new company (very similar to
Sojourner v Robb - would be a breach of s 131), and the new company would then trade under the
Compass Roofing name either as a company name or trading name, with the old company being put into
liquidation.
● Mr Spence had also become personally bankrupt in 2018, and thereafter had arranged for his de facto
partner Ms Brechelt to be named as a director of the relevant companies (since Mr Spence could not be a
director as he was bankrupt). However, in fact Mr Spence continued managing each of the companies in
turn under the position of “quantity surveyor” - he was pulling the strings and managing the companies,
despite his partner being formally the director.

Offences - Mr Spence:
● Breach of s 138A (acting contrary to best interests of company) - offence provision that works in
combination with s 131. If you act in bad faith and in a way that you know is contrary to the interests of the
company, then that can be an offence provision under s 138A.
● Breach of s 386A (taking part in management of phoenix company)
● S 262 (failing to comply with requests from liquidator for company documents)
● Various offences under Insolvency Act (including taking part in management of the company while
bankrupt).

,#M%&)5#a)05#&0<+#b;b#/+)4*#2%4#)55#%2#&'%*+#%22+"(+*#0"#(%<$0")&0%";#M'+#<)Y0<-<#.+")5&/#-"3+4#*#VW8G#)5%"+#0*#b#

/4*#0"#a)05;#A%#%@+4)55#a)05#&+4<#=)*#5%"1+4#&')"#&')&#$+()-*+#0&#&%%F#0"&%#)((%-"&#%&'+4#%22+"(+*;#

Offences for Ms Brechelt:

● S 386A (being a director of a phoenix company)
● S 386A (aiding or abetting Mr Spence to take part in management of phoenix company)
● Under Insolvency Act (aiding or abetting Mr Spence from taking part in management of company while
bankrupt)

55
,#I*#B4+('+5&#*+"&+"(+3#9C)"-)4/#7[7[:#&%#8#<%"&'*#(%<<-"0&/#3+&+"&0%"E#6b[#'%-4*#(%<<-"0&/#=%4FE#67#<%"&'*#
*-.+4@0*0%";#

Ricketts v Ad Valorem Factors Ltd (English CA):

!"#$%"&$'%()*"+',&-(."&/'0)1)'(1")("'2/"3+4"$-0%"5%%("4-6%("7/',"4$%"89":(1';0%(+."3+4"&/'0)1)'(1<"

Facts:
● Mr Ricketts was the director of a company called Air Component Co Ltd that went into liquidation. He was
also director of Air Equipment Ltd which then changed its name to Air Equipment Co Ltd and then in turn
went into liquidation.
● One of Air Equipment’s creditors sought to recover a sum owing for goods from Mr Ricketts.
● Recall - the way the legislation works is if you have got a company with a similar name, you can be held
liable personally for the debts of that second company where the 1st company has gone into liquidation.
Whether this particular case would have given rise to an issue under our legislation, not sure. It may be
that the group of companies exception might have applied here under the NZ legislation. But that
was not the case in the UK.
● Mr Ricketts was held liable for the debts of Air Equipment Co Ltd - as it was held to have a sufficiently
similar name to Air Component Co Ltd which was the failed company.
● The Judges in the English CA talk about - how do you decide whether the names are sufficiently similar to
suggest an association between the companies under the legislation.

Mummery LJ:
● “It is necessary to make a comparison of the names of the two companies in the context of all of the
circumstances in which they were actually used or likely to be used: the types of product dealt in, the
locations of the business, the types of customers dealing with the companies and those involved in the
operation of the two companies.” [22]
○ You have got to look at all of that context. Were the 2 companies dealing in the same type of
product? If you think back to Sojourner v Robb - Aeromarine 1 and 2 were both boat building
companies. Location of the business - both set up at the same location. Types of customers /
dealings with customers - same. Those involved with the operation of the companies - had the
same staff. You take all of those facts into account in deciding whether in that context the names
are sufficiently similar as to suggest an association between the two companies.

Simon Brown LJ:

● Similar comments from Simon Brown LJ - similarity between the two names must be such as to give rise to
a probability that members of the public, comparing the names in the relevant context will associate the two
companies with each other [30].

PROBLEM QUESTION - Issues on sale of assets from insolvent company to new company:
● Might be faced with a fact situation where you are asked to give advice about a company that may not be
in liquidation - but close to it, looks like it is on the path to liquidation. And the directors of the company say
to you - before the company goes under, we would like to transfer the assets of the company to a new
company and set up that new company so that the business can continue on and we would like to still be
involved.
● You have to think very carefully about that situation in giving advice to these directors.
● First, make sure that if there is going to be such a sale to the new company, that the value paid is market
value - that there is an independent valuation obtained, otherwise there is going to be the risk for
liability of the directors to the old company under s 131 as per Sojourner v Robb.
● Second, then also think about the potential risks in terms of the phoenix company legislation. Both the
offence provision and the potential liability of those involved in the new company - personal liability under s
386C think it is.
● Even if the assets have been transferred to the new company at market value and so there is on issue
under s 131, if the new company name - either its corporate name or its trading name - is sufficiently

56
 similar to the failed company’s name as to suggest an association with it, then the directors could be held
to be in breach of the phoenix company statutory provisions, which prohibit being the director of a phoenix
company or being involved in the management of the phoenix company leading to offence and personal
liability of the debts of the new company as well.
● So it might be that you are saying to them - let’s make sure the new company has a different name
(different trading name and corporate name), so that the phoenix company provisions do not apply.

Duty to Act for Proper Purposes:

Section 133:
“A director must exercise a power for a proper purpose”

Relationship with s 131:

● As a director, you can breach the s 133 duty to act for proper purposes even when you are acting in good
faith and in what you believe to be the best interests of the company.
○ Howard Smith is a good example of that.

● Hogg v Cramphorn: [English case on issue of shares]

○ Stands for the proposition that even if the directors are not motivated by personal advantage,
and even if they believe that they were acting in the best interests of the company - that is
irrelevant to whether there is a breach of the duty to act for proper purposes.
■ “It is also common ground [between the plaintiff and defendant] that the directors were not
actuated by any unworthy motives of personal advantage, but acted as they did in an
honest belief that they were doing what was for the good of the company . . . such a belief,
even if well-founded, would be irrelevant.”
■ Following standard form discretion did not prevent judicial review “the shares shall be
under the control of the directors, who may allot or otherwise dispose of the same to such
persons, on such terms and conditions, and at such times as the directors think fit.”

What is the test that you take for deciding whether there is an improper purpose?
● The law is not entirely clear as to the approach that should be taken where there are multiple purposes.
○ i.e. how do we weigh up a proper purpose, with an improper purpose.

● In the Australian case of Howard Smith v Ampol that went to the Privy Council, a ‘primary purpose’ test
seemed to be applied.
○ The Court held that there was a breach of duty by the directors of Millers in issuing shares, as it
held that their primary purpose was clearly to destroy the majority shareholding of Ampol and
Bulkships so that the takeover offer of Howard Smith could proceed, as opposed to satisfying the
company’s requirements for $10 million in capital.

● In the recent 2015 decision of Eclairs Group, Lord Sumption expressed support for the application of a
‘but for’ test.
○ In approving of Whitehouse v Carlton, he said “I think that this is right. It is consistent with the
rationale of the proper purpose rule. It also corresponds to the view which courts of equity have
always taken about the existence of powers of appointment by trustees.”

○ “One has to focus on the improper purpose and ask whether the decision would have been made if
the directors had not been moved by it. If the answer is that without the improper purpose(s),
the impugned decision would never have been made, then it would be irrational to allow it
to stand simply because the directors had other, proper considerations in mind as well, to
which perhaps they attached greater importance. Correspondingly, if there were proper
reasons for exercising the power and it still would have been exercised for those reasons even in
the absence of improper ones, it is difficult to see why justice should require the decision to be set
aside.”

57
 ■ This ‘but for’ test reflects a movement away from the primary purpose test which was
perhaps the way the High Court of Australia had applied the test in the earlier decision of
Howard Smith v Ampol.

○ Lord Hodge agreed with this approach, and Lord Clarke (with whom Lord Neuberger agreed)
inclined to agree. Lord Mance (with whom Lord Neuberger also agreed, noted some arguments in
favour of a test based on principal or primary purpose.

● Importantly, this test was not only favoured in Eclairs. In that case, Lord Sumption was largely relying on
Whitehouse v Cartlon, where the High Court of Australia suggested that a ‘but for’ test was the most
appropriate. Thus, there is quite a lot of authority for Lord Sumption’s “but for” test.
○ Whitehouse v Carlton -
■ “As a matter of logic and principle, the preferable view would seem to be that, regardless
of whether the impermissible purpose was the dominant one or but one of a number of
significantly contributing causes, the allotment will be invalidated if the impossible
purpose was causative in that sense that, but for its presence, “the power would not
have been exercised.”

,#GJJDQ#M\U#MUAM#MK#M\U#OGPMAe#UNRGRU#Z!M\#M\U#OGPMA;#

,#!N#GNQ#JLKBDUI#SE#QKT#_UO!N!MUDQ#NUU_#MK#_!APTAA#Z\GM#!A#M\U#fNKLIGDg#JTLJKAU#KO#M\U#

UhULP!AU#KO#M\U#JKZUL#9+;1;#4)0*0"1#().0&)5#2%4#&'+#0**-+#%2#*')4+*:;#

The Duty to Act for Proper Purposes is a Duty owed to the Company:
● S 169 says that this is a duty owed to the company.

● However Peter Watts says that the CL duty treated the duty as a duty to shareholders.
○ You can see that if the duty is being applied in circumstances where we are talking about internal
matters - e.g. transfer of shares, issue of shares, vulnerability of shareholders to exercise votes
attaching to shares as in Eclairs, then you might well have thought the duty was owed to
shareholders. But that is not want s 169 now says.

● The Law Commission when pulling together their report No 9, proposing the new Companies Act, weren’t
convinced that the duty to act for proper purposes needed to be kept. They thought all you need is a s 131
duty - duty to act in good faith and in the best interests of the company. So the Law Commission in the
draft act attached to report No 9 did not include a duty to act for proper purposes. However, this was
overruled by the Justice department who included s 133.

● Peter Watts’ textbook suggests that maybe you could use the CL duty to act for proper purposes so
as to allow shareholders to sue directly (i.e. to give personal standing). But not sure about that. Given
that the duty to act for proper purposes has now been enshrined in the statute specifically, and given we
are told by s 169 that the duty is owed to the company and not to shareholders, then I think would be
inconsistent with that to suggest the CL duty survives alongside the statutory duty in s 133.

● Potentially, does create some enforcement issues:

○ Damages: If the shareholder wants to claim damages, he or she might need the company to bring
the action against the directors for breach, or the shareholder could potentially bring a shareholder
derivative action on behalf of the company under s 165.

○ Injunctive Relief: Injunctive relief under s 164 for breach of the proper purposes duty is available
to shareholders even if the duty is owed to the company. Mandatory injunction orders can also be
sought.
■ E.g. in a situation where the directors were proposing to issue shares for an improper
purpose, there would be no reason why a shareholder could not enforce that duty by
seeking an injunction under s 164.
58
Background to Proper Purposes Doctrine (Eclairs v Glengarry):

Main uses of the proper purpose doctrine:

At CL, the main uses of the proper purposes duty were in relation to decisions that have an internal aspect (e.g.
internal governance like power of particular shareholders as against each other, or relative power as between
shareholders and directors), as opposed to dealing with 3rd parties like company contracting.

❖ Issuing shares to alter the balance of voting power (Howard Smith)

➢ If shares are issued for the genuine purpose of raising capital - that is fine, no issue.
➢ However in Howard Smith, that was not what the Board was doing. The shares were issued to
destroy the majority shareholding to ensure that the Howard Smith takeover offer of Millers could
proceed. That was not a proper purpose for the issue of shares.

❖ Declining to approve the transfer of shares:

➢ The constitution may include particular reasons why the directors may refuse to register the
transfer of shares - i.e. pre-emptive rights provisions on the transfer of shares are not complied
with.
➢ However, if their reason for refusing is because they don’t like the shareholders coming in, or think
those particular shareholders coming in are likely to vote them out, then that is not a proper
purpose for that kind of decision.

❖ Forfeiting shares:
➢ Company constitutions will often provide for shares to be forfeited, where there has not been
payment by shareholders of calls under their shares.
➢ However, if the directors have exercised that power to forfeit shares, not because they are trying to
ensure payment be made under the shares, but because they don’t like that particular shareholder
or that particular shareholder is going to vote to remove them from the board, that would be an
improper purpose.

❖ Imposing restrictions on the rights attached to shares (Eclairs Group)

➢ Sometimes there may be provisions in the constitution that allow the directors to impose
restrictions on the exercise of rights - voting rights, rights to dividends etc - that are otherwise
attached to shares.
➢ We will see in Eclairs that there may be specific reasons why the directors can do that (e.g. non-
compliance with disclosure notice).
➢ However, if the directors impose restrictions on those rights not for those reasons, but for purposes
relating to them keeping control or certain shareholders keeping control, that would be an improper
purpose.

However, it is possible that the duty to act for proper purposes could have wider ramifications beyond matters of
internal management, and it has been used more widely in some cases.

❖ Westpac v Bell case:

➢ Directors entered into loan or banking documents with Westpac, and those contracts were
attacked on the basis that this was done in such a way that it was a breach of the director’s duty to
act in the best interests of the company, but also that it was for improper purposes.
➢ This was perhaps a strained use of the proper purposes doctrine in that case, but it is an example
where the duty has been sought to be applied more widely than it usually has been at CL.

Proper Purposes Cases:

Illustrate the kind of circumstances in which decisions by directors can be found to be in breach of the duty to act
for proper purposes.
59
Howard Smith v Ampol(1974) (Aus case on appeal to the PC) [issue of shares]:
Facts:
● A company called Millers had 2 main shareholders Ampol and Bulkships, who had some association and
between them held 55% of the shares (i.e. a majority among them combined). There was a takeover battle for
Millers, and Ampol made a formal offer for all the shares at $2.27 per share. The directors of Millers met and
said it was too low, and recommended that the offer be rejected.

● Howard Smith then announced an intention to make a takeover offer at $2.50 per share - quite a bit more than
Ampol had offered.

● Ampol and Bulkships issued a press statement that they would act jointly and reject any offer for their shares,
including from Howard Smith.
○ This gave the message to the other shareholders that there was no point voting in favour of the offer
because Ampol and Bulkships between them held more than 50% of the shares.
○ It also gave the message to Howard Smith that there was no point in pursuing the offer.

● Howard Smith came up with a plan together with Millers management for Millers to make an issue to
Howard Smith of sufficient size to convert Ampol and Bulkships’ shareholding together to less than
50% of shares, so that Howard Smith could still pursue its offers. As the Howard Smith offer was larger
than the Ampol offer, there was every prospect of it succeeded because other shareholders would be likely to
accept it. If that happened, then Howard Smith would get control of Millers.

● Millers took legal advice about the proposed issue of shares to Howard Smith, and the advice was that it
would only be justified if it was bona fide related to the capital requirements of Millers. Millers did need about
$10 million to finance some tankers under construction and generally to secure its financial position.
So the company therefore calculated that at an issue price of $2.30 per share, 4.5 million shares needed to be
issued to come up with the capital required of $10 million.
○ Howard Smith wrote to Millers applying for the 4.5 million shares at $2.30 per share. The Board
considered this and voted 4-2 to accept the proposal.

● Ampol brought proceedings to seek to set aside the share issue, on the basis that it was for an improper
purpose.

Held:
Duty to act in best interests of the company:
● Australian Trial Judge (Sir Lawrence Street) first held that the Millers directors had not breached their duty to
act in the best interest of the company. It was not like they were acting in bad faith, or not in the best interests
of the company. They did honestly believe that they were acting in the best interests of the company, they
weren’t motivated by any personal gain or wanting to preserve their position. They were just trying to do the
best that they could for the shareholders.

● However, the fact they were acting in what they believed was the best interests of the company, was not the
end of the matter (i.e. in NZ - s 131 duty is different from the s 133 duty to act for proper purposes). You would
still be acting for an improper purpose even though you honestly believe you are acting in the best interests of
the company.

Duty to act for proper purposes:

● The issue was what was the primary purpose of the majority of directors?
○ Was the primary purpose to satisfy Miller’s need for capital ($10 mil of those tankers); or
○ To destroy the majority shareholding of Ampol and Bulkships so that Howard Smith’s takeover offer
could proceed.

● Trial Judge held that clearly the primary purpose was to destroy the majority shareholding of Ampol and
Bulkships, so that the Howard Smith offer could proceed. That primary purpose of the share issue was an
improper purpose, and therefore the directors had breached their fiduciary duty.
○ The Privy Council upheld the Trial Judge’s finding to that effect.

● Privy Council - “Just as it is established that directors, within their management powers, may take decisions
against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control
them in the exercise of these powers while they remain in office (Automatic Self-Cleansing), so it must be
unconstitutional for directors to use their fiduciary powers over the shares in the company purely for
the purpose of destroying an existing majority, or creating a new majority which did not previously
exist.”
○ The constitution separation of powers between directors and shareholders is important
○ Directors have powers of management and shareholders can’t usurp that - Automatic Self Cleansing.

60
 ○ On the other hand, directors should not interfere with the powers of shareholders either. Shareholders
have the right to choose whether to buy or sell their shares, and they can control who should be the
directors of the company by appointing or removing them.

● The right to dispose of shares at a given price is essentially an individual right to be exercised on individual
decision and on which a majority, in the absence of oppression or similar impropriety, is entitled to prevail.
Directors are of course entitled to offer advice, and bound to supply information, relevant to the making of such
a decision, but to use their fiduciary power solely for the purpose of shifting the power to decide to
whom and at what price shares are to be sold cannot be related to any purpose for which the power
over the share capital was conferred upon them.
○ I.e. directors should not interfere with the balance of powers as between shareholders.

K)%18$"'3"3-4(8-1)2"4(*2"!"A'-415.%"1*"%E(-*2"(/.%++"?)4"61)*2"-//'8%/*>"
● Because there was a breach of the duty to act for proper purposes, which is a fiduciary duty, the underlying
transaction for the issue of the shares was voidable at equity unless the 3rd party (Howard Smith) was
innocent - i.e. he was not aware of the breach of fiduciary duty / improper purpose of the directors in issuing
the shares.
○ If he was not aware, then he would be innocent and so the issue of shares would not be voidable
against him.
○ However, Howard Smith participated in this whole plan. It was a plan created between Howard Smith
and the directors of Millers to ensure that the Howard Smith takeover could succeed. Thus, there was
essentially knowledge of the situation by Howard Smith which meant the transaction was still voidable
against him - he could not be considered innocent.

Whitehouse v Carlton Hotel (HCA) (1987): [issue of shares for improper purpose]
Facts:
● The father who was largely managing the company, fell out with his ex-wife and daughter. The father felt that
the ex-wife and daughter were unsettling the affairs of the company, and so he came up with a plan to try and
fix them - he issued further shares to his sons. That issue of shares was made so that he (the father)
could retain control and ensure the smooth operation of the family business against the
disruptiveness of his ex-wife and daughters.
● The father later fell out with his sons.
● He went to Court and said that when he arranged for the issue of shares to his sons, he did not do that
because the company needed the money / because of its capital requirements. Rather, he did so in order to
ensure control of the company, which was an improper purpose, and so the issue of the shares should be set
aside.
○ i.e. he was essentially complaining of his own improper purpose.

Held:
● The father won - the majority held that the issue of shares was made for an improper purpose, and therefore it
was voidable and should be set aside.

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Fraser v Whalley [issue of shares to friendly parties to allow directors to remain in office]
● Directors of a railway company wanted to issue new shares to friendly parties to ensure that a planned
shareholder resolution for their removal as directors would fail, because they knew that the friendly parties
would vote against the resolution for their removal.
● That was an issue of shares for an improper purpose.

Cannon v Trask [setting time of AGM for improper purpose]

● Concerned the setting of time for a shareholder general meeting (directors have some power to do that).
● The directors knew that if they set the time for the general meeting at a time when parties / shareholders that
are opposed to them can’t turn up, then they have a much better chance of getting the shareholder resolutions
that they want passed being passed. Therefore, they deliberately set the time for the AGM at at a time when
certain shareholders could not turn up.
● That was the exercise of a power for an improper purpose.

Anglo-Universal Bank v Baragnon [calls on shares for improper purpose - stop certain SHs voting]
● Case involving director’s power to make a call on shares.
● There are amounts owing on shares by shareholders - they have to pay up these amounts at some time
● Under the constitution of the company, if a call on shares was made and the shareholder had not paid up, then
the shareholder would lose their voting rights until they did pay up.
● In this case, a call on shares was made not because the company needed the money, but because the
directors wanted to ensure that certain shareholders could not vote at upcoming shareholder’s
meeting.
● That was held to be the exercise of a power for an improper purpose.

Lee Panavision (English CA) [entry into 2nd management agreement for improper purpose]
● In 1988, company called Lighting had entered into mgmt agreement with Lee Panavision. This gave
management rights over Lighting in favour of Panavision, and gave Panavision the power to appoint directors
to the Board of Lighting. This was done to support an option to purchase the shares in Lighting that Panavision
had.
● At the end of 1990, the option to purchase was going to expire, and along with it the management agreement.
● As it was clear the shares in Lighting were not going to be sold, the major shareholder of Lighting (Westwood)
on the expiry of the option and management agreement wanted to replace the board and retake control of
Lighting.
● Panavision did not want to lose their management rights, as they had through a subsidiary made a
loan to Lighting and so wanted to retain control of Lighting while the loan was in place.
● The directors appointed by Panavision therefore purported to enter into a 2nd management agreement that
would continue on past the expiry of the first one and the expiry of the option, giving Panavision ongoing
management rights in respect of Lighting.
● The entry into the 2nd management agreement by the directors was held to be for an improper
purpose - essentially preventing the shareholder from exercising their normal power of being able to
replace the board.

○ Dillon LJ - “The function of the directors is to manage, but the appointment of the directors who are to
do the managing is constitutionally a function of the shareholders in general meeting. Therefore, it
must have been unconstitutional for the directors, knowing . . . that the shareholders were proposing
as soon as they could to exercise their constitutional right to appoint new directors, to take all
managerial powers away from any new directors who might be appointed by committing Lee Lighting
to the second management agreement and giving exclusive managerial power to Panavision over the
possibly crucial period until the end of April 1992.”

Eclairs Group: (UK SC) (2015):

Facts:
● Glengarrys and Eclairs had built up significant shareholings in JKX Gas. There was some association between
them and they had a reputation as corporate raiders.
● Glengarrys and Eclairs wanted to replace the CEO with their own one and replace the Board.
● The existing board of JKX Oil called a general meeting of shareholders, at which one of the resolutions was
going to be for the re-election of the CEO who Glengarrys and Eclairs wanted to replace, and other resolutions
relating to the issue of shares that they were not happy about.

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 ● In the context of all this, the Board issued disclosure notices under the constitution of JKX Gas, requiring
Glengarrys and Eclairs to provide details of their shareholdings. The board considered that the information
provided was not full and correct, and exercised a power provided for under the constitution where disclosure
notices were not answered properly, to issue restriction notices to the relevant shareholders which
prevented them from being able to vote and exercise other rights during the period when they were in default
of disclosure notices.
● Eclairs and Glengarry argued that the issue of the restriction notices was for an improper purpose - to
prevent them from being able to vote at the AGM, at which the CEO was going to be re-elected that
they wanted to get rid of.
○ They went to Court and sought an urgent injunction to stop the AGM from taking place without their
votes being considered. In the end, there was a resolution whereby the AGM took place and they
were allowed to vote, but the counting votes as to whether that was considered valid or not was
considered later.

Held:
● 1st instance Judge held that the restriction notices were invalid b/c they were issued for an improper purpose -
the purpose of preventing Eclairs and Glengarry from being able to vote on the resolutions at the AGM. That
was overturned by the CA but was reinstated by the SC.

● Case talks about the test for deciding whether there is an improper purpose, where there are multiple
purposes:
○ Lord Sumption - “if there were proper reasons for exercising the power and it would have been
exercised for those reasons even in the absence of improper ones, it is difficult to see why justice
should require the decision be set aside.”

● Lord Sumption said that art 42 (article that provided for the issue of restriction notices preventing shareholders
from being able to vote where they did not comply with disclosure notices) has 3 closely related purposes:
○ The first is to induce the shareholder to comply with a disclosure notice
○ Secondly, the article is intended to protect the company and its shareholders against having to make
decisions about their respective interests in ignorance of relevant information.
○ Thirdly, the restrictions have a punitive purpose. They are imposed as sanctions on account of failure
or refusal of the addressee of a disclosure notice to provide the information for as long as it persists,
on the footing that a person interested in the shares who has not complied with obligations attaching
to that status should not be entitled to the benefits attaching to the shares.

● These three purposes are all directly related to the non-provision of information requisitioned by a
disclosure notice. None of them extends to influencing the outcome of resolutions at a general
meeting. That may well be a consequence of a restriction notice. But it is no part of its proper purpose.
It is not itself a legitimate weapon of defence against a corporate raider, which the board is at liberty to take up
independently of its interest in getting the information.
○ Therefore, restriction notices were made for an improper purpose and so they were set aside as
invalid.

Impact on Transactions:
● We have already talked about how breach of fiduciary duty to act in the best interests of the company (s
131) will make the underlying transaction voidable at equity, unless the 3rd party is innocent
○ Kinsela v Russell, Autumn Tree.

● The position is the same with breach of fiduciary duty to act for proper purposes (s 133) - the underlying
transaction will be voidable in equity, unless the 3rd party is innocent.
○ Bamford v Bamford (English decision).

● Potentially, s 18(1)(a) may be of some relevance here - says that the company cannot rely on a breach of
the Act or the constitution. Here, the breach of the Act would be s 133 (duty to act for proper purposes) -
the company cannot rely on that breach unless the 3rd party knew or ought to have known because of their
relationship with the company, of the breach.
○ So s 18(1)(a) may be of potentially some relevance to a situation like this, however whether it
would have a lot of relevance to the underlying transaction being voidable - not sure.
○ The transaction is only going to be voidable anyway if the 3rd party is not innocent - so the
interrelationship between equity and the proviso under s 18(1) probably does not create that much
of a different position.

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Ratification of Breach of Proper Purpose Duty:
● Where shares are issued in breach of the duty to act for proper purposes, then the new shares cannot be
voted in the ratification resolution. The ratification resolution must be by the shareholders as they were
before the impugned issue of the shares (Hogg v Crampthorn, Banford v Banford)
○ I.e. Howard Smith - Board of Millers issued shares to Howard Smith, to destroy the majority
shareholding of Bulkships and Ampol to help the takeover offer of Howard Smith to proceed. That
was held to have been in breach of the duty of the directors to act for proper purposes. Howard
Smith and the other shareholders would not then be able to say we will exercise our powers as
majority shareholders to ratify the breach of fiduciary duty so that we can keep our shares.
○ In a breach of proper purpose case, if the shareholders want to ratify the breach of duty and affirm
the issue of shares, then that needs to be a shareholder resolution by the shareholders, as they
were before the impugned issue of shares.

RATIFICATION / RELEASE OF BREACHES OF DIRECTOR DUTIES:

If directors have breached their duty for whatever reason, the company has a right of action against them. To what
extent can the company release the directors from that breach?

❖ Release / ratification of breaches of director’s duty involves forgiveness of the directors for the breach,
such that the company gives up its right to sue the directors for the breach. This is a different concept
to ratification / adoption of unauthorised transactions, however release of breaches of director’s duties
where a transaction would otherwise be voidable for breach of fiduciary duty may also amount to
affirmation of the transaction.
➢ I.e. it is possible that when the company says we are no longer worried about this breach of
fiduciary duty, we both release the director from any claim against them, and we also confirm or
affirm that the transaction entered into can go ahead - we give up our right to set that aside.

❖ Although ratification / release of breaches of director duties is a management decision (as it concerns the
company giving up a right to sue), the Courts have said that this is an exception to the principle that powers
of management lie with the Board. The shareholders are the appropriate organ to ratify / release
breaches of director duties, because it would not make sense for directors to be able to unilaterally
excuse their own failure to perform.

➢ Equiticorp v Industries Group (Smellie J): Justice Smellie takes the view, consistent with earlier
cases as well, that the release or ratification of breaches of fiduciary duty has to be by the
shareholders, not the board:
■ “It cannot be that directors can unilaterally excuse their own failure to perform. That would
frustrate the policy behind the concept of the imposition of fiduciary duties. In order to
maintain that policy I consider the shareholders in general meeting alone must be vested
with the power to ratify the directors’ unauthorised actions. It cannot reside in the directors
themselves.”
● He uses the term ‘unauthorised action’, but think in the context it must also extend
to the breaches of fiduciary duty, because that is what he is talking about in the
2nd sentence.

❖ Equiticorp is a case prior to the CA 93 and so it is talking about the CL rules for ratification for breaches of
director duties. However, the CL rules of ratification of breaches of director’s duty have been preserved by
s 177(4) of the CA 93.

Section 177 - Ratification:

● (1) The purported exercise by a director or the board of a company of a power vested in the shareholders
or any other person may be ratified or approved by those shareholders or that person in the same manner
in which the power may be exercised.

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 ● (3) The ratification or approval under this section of the purported exercise of a power by a director or the
board does not prevent the Court from exercising a power which might, apart from the ratification or
approval, be exercised in relation to the action of the director or the board.

● (4) Nothing in this section limits or affects any rule of law relating to the ratification or approval by the
shareholders or any other person of any act or omission of a director or the board of a company.
○ NZ cases since the passing of the 1993 Act have confirmed that section does have that effect of
confirming the CL rules relating to ratification. In particular, a case called Macfarlane v Barlow -
that was a case under the 1993 Act where Venning J went through the common law rules relating
to ratification of breaches of director duty, including cases such as Daniels v Daniels, and says
those rules are preserved by s 177(4).

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Section 162 extract:

(1) Except as provided in this section, a company must not indemnify, or directly or indirectly effect insurance
for, a director or employee of the company or a related company in respect of -
(a) Liability for any omission in his or her capacity as as director or employee

(9) “indemnify” includes relieve or excuse from liability, whether before or after the liability arises.

● Of course, that is exactly what ratification does at CL - shareholders can in certain circumstances excuse
directors from liability for their breaches of duty when acting as a director. Section 177(4) was introduced
into the legislation later, and it really looks like this is a bit of a drafting error that Parliament did not
recognise that in addition to putting in s 177(4) to deliberately try and preserve CL principles relating to
ratification, that it was also necessary to perhaps amend s 162 so that that was subject to s 177.

● JL takes the view that the better view is that s 177(4) preserves the CL despite s 162. That is certainly
the view that is expressed by Lynn Taylor in the Watts and Taylor textbook. Chapter that deals with
ratification takes that view.
○ Section 177(4) was added into the legislation later on but would be undermined if s 162 prevented
the ability to ratify. And as said, cases such as Macfarlane v Barlow have confirmed that s 177(4)
does preserve the CL principles relating to ratification.

CL Principles of Ratification:
At CL, to ratify / release a breach of director’s duty, you needed either:

❖ Properly Notified General Meeting = Could ratify by majority resolution at properly notified general
meeting. Shareholders must be told beforehand what they are being asked to ratify, with sufficient
information about that breach of duty so that they can decide whether to attend and assess whether or not
to ratify that - Heatherington v Carpenter (1997) (CA).

❖ Unanimous Assent = If no properly notified general meeting, ratification could be unanimous. Even in
circumstances of unanimous shareholder assent though, the shareholder should still be given enough
information to assess whether or not it is appropriate to ratify or release the breach of director’s duty.

Fraud on the Minority Exception:

❖ General rule at CL was that breaches of director duties could be ratified / released by a majority resolution
of shareholders. This is subject to an exception for fraud on the minority. Where a director has personally
benefited from a transaction, the director cannot themselves exercise their majority shareholding powers to
ratify their own breaches, because this would effectively amount to a fraud on the minority.

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 ➢ In Macfarlane v Barlow, Venning J went through the CL rules relating to ratification of breaches of
director duties, and said that those rules, including cases such as Daniels v Anderson, are
preserved by s 177(4).
❖ In such a case, the ability to ratify must be exercised by unanimous support.

Daniels v Facts:
Daniels ● Bernard & Beryl Daniels were the directors and majority shareholders of a company Ideal
(1978) Homes (Coventry) Limited.
(English ● They had caused the company to sell one of its properties to Beryl for $4000p, and it seems
Ch) fairly clear that this was a gross undervalue. She then re-sold the property 4 years later for
$112,000p, making a huge profit.
● The minority shareholders (45%) claimed the directors had breached their duty of care by
selling this property at a gross undervalue to one of themselves, and sought to bring an
action in the name of the company against the directors.
● Beryl and Boris Daniels said they could ratify this breach of duty b/c they were the majority
shareholders.

Held:
● The Court said they could not ratify.
● Where a director has personally profited from a transaction, to allow the director by
exercising their majority shareholding powers to ratify their own breach, would amount to a
fraud on the minority.
○ I.e. having personally profited, the directors cannot protect themselves by majority
shareholder resolution in their favour.
● Therefore, the ability to ratify would not be able to be exercised in the case without
unanimous support.

Company is Insolvent / Likely Insolvent:

❖ Where a company is insolvent / likely to become insolvent, then shareholders cannot ratify breach of duty
to act in good faith and in the best interests of the company, even unanimously
➢ Sojourner v Robb (CA, Singularis v Daiwa (2019) (UK SC)

Shares issued in Breach of Proper Purpose Duty:

❖ Where shares are issued in breach of the duty to act for proper purposes, the new shares cannot be
voted in the ratification resolution.

➢ E.g. Howard v Smith - Board of Millers issued shares to Howard Smith to destroy the majority
shareholding of Ampol and Bulkships to help Howard Smith’s takeover offer of Millers to succeed.
That was held to be in breach of duty to act for proper purposes. If Howard Smith has said that
now that we have got our majority shareholding, we will vote together with the other shareholders
in Millers (other than Ampol and Bulkships) to ratify that breach of fiduciary duty to act for proper
purposes, so that we can keep our shares, that is not allowed.

➢ In a breach of proper purpose case, if the shareholders want to ratify the breach of duty and affirm
the issue of the shares, then that needs to be by shareholder resolution by the shareholders as
they were before the impugned issue of the shares.
■ So it would have to be the majority of shareholders not taking into account Howard Smith.

Directors must Make Proper Disclosure:

● Directors must make proper disclosure in relation to the breach - Heatherington v Carpenter (case
involving shareholder meeting).
● The proposition that there needs to be proper disclosure is true even in a case of unanimous shareholder
ratification in the absence of a shareholder meeting - Pascoe v Lewis.

Ratification of Interested Transactions Voidable under S 141:

❖ If an interested transaction is voidable under s 141, then it can only be ratified by unanimous written
resolution of shareholders under s 107(3) and (4).
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 ➢ Today, Daniels v Daniels would be regarded as an interested transaction under s 141 of CA 93 -
company sold a property to one of the directors Beryl Daniels, and so the director Beryl was
interested in that transaction. That transaction would therefore be voidable, unless fair value was
obtained, and the whole argument in the case was that FV was not obtained.

➢ If the company did not receive fair value, the interested transaction can be avoided within 3 months
of being disclosed to the shareholders under s 141. The transaction can only be ratified by
unanimous assent of the shareholders in writing, not majority shareholder resolution.

Shareholder Oppression under s 174:

❖ In some cases, shareholder ratification may also amount to oppression under s 174 - unfairly prejudicial
conduct: Jenkins v Enterprise Gold Mines.
➢ In Jenkins, there were some unwise transactions that took place. The directors who had been
responsible for those unwise transactions, then sought to get the shareholders to ratify the
transactions and their actions, and the very fact of endeavouring to do so, was held to amount to
unfairly prejudicial conduct in that case.

67