Steering the Ship onto Rocks: Directors Flouting Obligations

In a series of recent prosecutions, the Australian Securities & Investments Commission (“ASIC”) has bared its watchdog teeth and brought proceedings against a number of directors who have failed to comply with their statutory obligations.

We look at three decisions in which the penalties imposed on the individual directors have been significant – demonstrating that ASIC is no longer prepared to sit back and watch directors flouting their duties.

Director receives prison sentence

The former director of Almatt Pty Ltd, Alex Paul Gavriel was sentenced to 20 months in prison following a finding that he had dishonestly used his position as a director to gain a personal advantage.

Gavriel had withdrawn some $137,000 from Almatt's company coffers for his personal use. After everything went pear-shaped with the business – perhaps unsurprisingly given the large unauthorised account withdrawals – Gavriel failed to assist the liquidator as required or to disclose details of those withdrawals.

Ultimately, Gavriel pleaded guilty to a contravention of Section 184(2) of the Corporations Act, 2001 (“the Act”) namely using his position dishonestly to gain an advantage for himself.  

According to ASIC Commissioner, Greg Tanzer, the clear message from the watchdog following the conviction and imposition of the penalty given to Mr Gavriel is that it will "ensure any director considering this type of misconduct feels the full weight of the law."

Lighter sentence for Adelaide director

A similar outcome, albeit with less severe personal consequences for the subject director, was handed down in the Adelaide Magistrates Court in March 2016 against Joseph Cogno, director of Middlebrook Estate Pty Ltd. Cogno had failed to provide a Report as to Affairs and to deliver the Company’s books and records to the liquidator of Middlebrook.

As a result of these defaults, Cogno was given a three-month suspended sentence. He was also ordered to enter into a good behaviour bond requiring compliance with his obligations to and requests of the liquidator.

Breaches result in maximum disqualification

The Sydney director of various companies, Michael John Teys, was disqualified in January 2016 from managing any corporations for a period of five years – the maximum period of disqualification available.

He had committed several breaches of his director's duties, including using his position to improperly gain advantages, failing to exercise due care and diligence when managing loans, and acting with a lack of "commercial morality." His breaches ultimately meant that the three collapsed businesses owed more than $5 million to creditors.

ASIC signalling willingness to take action

During the 2014-2015 financial year, ASIC successfully prosecuted 355 individual directors on 680 similar breaches of directorial obligations.

So what does ASIC's current attitude mean? Directors who fail to comply with their obligations, and in particular those who do so for their own advantage, are going to be pursued and prosecuted, and the courts will impose high penalties to discourage future bad behaviour.

Partner Mike Smith Takes on Director-Related Transactions

As any liquidator is aware, unreasonable director-related transactions are not easily challenged. I was successful in the recent decision of Smith v Starke, in the matter of Action Paintball Games Pty Ltd (“APG”) (In Liquidation) (No 2) (2015) FCA 1119.

In my capacity as the Official Liquidator of APG, I pursued a claim against its directors for unreasonable director-related transactions under Section 588FDA of the Act.

Making the case

Over a period of approximately four years (between February 2008 and May 2012) the directors had made some $500,000 worth of payments to a financier from whom they had borrowed money to purchase land.

As liquidator, my observations included that the company was not legally required to make the payments, and continuing to make the payments deprived the company of the means to put the money towards a more appropriate purpose, such as paying creditors.

The business had experienced a significant downturn in 2008 and by the middle of 2010, superannuation guarantee charges totalling some $110,000 also became payable.

Taking into account the interests of the company's members, it was held in the Federal Court that the directors of APG should clearly have given early thought as to whether the loan repayments should continue to be made in preference to the superannuation payments.

In particular, the directors should have considered whether the company's solvency could support the maintenance of both payments.

According to the judgment of Her Honour, Gleeson J, a reasonable person in the position of the directors should have taken steps to commence the sale of the property as soon as the superannuation payment became payable, and given further thought as to whether the repayments should be ceased. It was held that a reasonable person in the position of the directors would have ceased making payments by December 31, 2010, having concluded that the business' performance continued to decline.

It was ultimately found that all payments on the loans made between January 1, 2011 and May 25, 2012 were recoverable as unreasonable transactions.

The implications of the decision

The decision clearly demonstrates that directors must at all times weigh the financial obligations of the company against its fiscal performance. This is an ongoing requirement – it’s not enough for the directors to consider whether a repayment was appropriate at a certain point in time, and then to put the issue out of their minds. Instead, directors have an obligation to continually assess whether business commitments, including loan repayments, remain viable now and in the future.

Further, directors must continuously give thought to what steps can be taken to remedy situations where ongoing payments are against the interests of the company, and to be prepared to action these steps, for example by proceeding with a sale process of assets.