Risky business

A recent Australian case is a reminder of the need for directors to act in the best interests of a company, as well as the risk of being found liable as a de facto director, even after resignation from office.

The case

Mr Phokos was the sole director of a company involved in distributing anti-virus and cyber security software.  The company went into liquidation in January 2017 after losing a significant distribution contract, selling assets to a company related to Mr Phokos, and becoming indebted to the Australian Tax Office.

Mr Phokos purported to resign as a director in October 2014 (and was replaced by another director), but the liquidator of the company argued that he continued as a director of the company until liquidation.  The liquidator claimed damages from Mr Phokos for over AUD1.8m of payments he caused the company to make to related companies and that he alleged were contrary to Mr Phokos’ duties to act in the best interests of the company and not to improperly use his position to gain an advantage.

Mr Phokos did not defend the liquidator’s claims and the New South Wales Supreme Court held that Mr Phokos continued as a de facto director after his resignation.  Following his resignation as a director, the Court found that Mr Phokos:

• corresponded with the company’s accountants in his capacity as a director of the company;
• was listed as a director in the company’s 2015 and 2016 company statements;
• signed a memo as a director about the company’s solvency in 2015;
• signed a finance lease as a director of the company in 2016; and
• swore an affidavit in 2016 describing himself as the sole director of the company.

The Court subsequently found that Mr Phokos breached his director duties in causing the company to make the payments in question.  A New Zealand court, faced with similar circumstances to the Phokos case, would have made the same findings.

The relevant law in Australia and New Zealand on de facto directors and also the duties to act in the best interests of the company and not to improperly use a directorship to gain an advantage is similar, although New Zealand has no statutory equivalent to section 182 of the Corporations Act 2001 (Cth) on the use of position, with liquidators likely to rely instead on either a breach of the duty in act in good faith or in the best interests of the company (section 131 of the Companies Act), or the equitable rules against a fiduciary using his or her position to make a profit.  Like Australia, New Zealand also requires directors to take into account the interests of creditors when a company is insolvent or close to insolvency.

In Australia, the test as to what amounts to an ‘improper’ use of position is an objective one. The standard applied is what is expected of a reasonable person with the same duties, powers and authorities. This extends to not obtaining a benefit for themselves or acting in a position of conflict. In this case, it was found that Mr Phokos breached these conditions.

In New Zealand, the test for a breach of section 131 is a subjective one: the director must act in what the director believes to be the best interests of the company. However, in practice, where the director has a conflict of interest and the foreseeable result of the act in question is to benefit the director to the detriment of the company, the court will be very reluctant to find that the director truly believed the act to be in the best interests of the company. If the director has simply not considered the impact on the company, he or she may also be liable in negligence.

What is a de facto director?

Company directors are either de jure or de facto directors: 

1. A de jure director is someone who has been properly and formally appointed to a company.
2. A de facto director is a person who has not been properly appointed as a director, and has no lawful authority to act as a director, but who nonetheless occupies the office of director and discharges some or all of the duties of a director.  A subset of de facto directors is the shadow director – someone who does not openly adopt the role of a director, but who controls the de jure director like a puppet.

Whether a person is a de facto director is a question of fact which depends on the functions, duties, and powers performed and exercised by that person in the circumstances of the company.  If you are held to be a de facto director, you can be liable to the company on the same basis that a de jure director is liable.

How can you avoid being a de facto director?

If you are yet to step up to a directorship, or you have just resigned from a board role, you will want to avoid being caught in the net as a director of the company if things go wrong. To reduce your risk of a court finding that you are a de facto director, we recommend that as a non-director you refrain from:

• making decisions for the company;
• issuing directives or instructions;
• representing to third parties that you are making decisions for the company (for example, by signing documents on behalf of the company or in which company decisions are implemented, or by using the word ‘director’ in your title);
• assuming responsibility for the company’s business;
• attending board meetings (if a non-director does attend board meetings, the minutes should record that they are attending as an observer only); and
• attaching conditions to any funding you provide to the company that could be seen as exercising control over the company (for example, conditions that stray into strategy and management of the company’s affairs). 

About the authors

Louise Massey is the global co-chair of Dentons’ litigation practice and has over 30 years of experience in a broad range of commercial disputes. She is a partner in our Sydney Disputes and Risk Advisory Group, a Dentons Australia Board member and a Dentons Global Board member. Her board roles enable her to bring a further layer of commercial insight to her matters and the competing market and regulatory demands faced by her clients.

James McMillan is a litigator who specialises in insolvency law, helping creditors and insolvency practitioners with businesses in financial distress. He leads the restructuring and insolvency team based in Auckland.

For more information about the case featured in this article, or about director duties in Australia or New Zealand, please contact us.