#7413 - Implications Of Limited Liability - Business Associations I

Class 3- Implications of limited liability

We consider the implications of limited liability, through examining a number of cases in which courts have ‘lifted the corporate veil’.

• Section 588G makes the directors liable for any debts that the directors are responsible for during insolvency. It includes when the debt they incur makes them insolvent.

ONE – the idea of lifting the veil

• Making shareholders & officers liable despite Salomon v Salomon

• Sham, fraud etc abuse of limited liability

• Externalities or costs on third parties

• Risks to creditors in trading out of trouble

• Absence principle? Series of single instances where bounds of commercial morality passed

• Corporate groups

TWO – Statutory instances

• Insolvent trading – s.588G & 588 V – X of the CA (these sections are the government trying to deal with the corporate veil when they incur debt when the business is expected to be insolvent. They are the director duties. 588G imposes liability on directors for failure to proper administer the company in relation to its debt capital. One of the trends of dealing with the inappropriate use of limited liability is to impose duties on the board.).

• Reforms proposed to s180(2) CA

• Breach directors duties s 180 – 184 CA action against James hardy board- breached director duties.

• Consolidation of accounts & cross guarantees BUT Industrial Equity v Blackburn (Another approach is to argue that accounts should be consolidated when a company is in trouble to bulk up the accounts- Industrial Equity v Blackburn said sorry but in a group context you don’t have to reveal consolidated accounts and if a creditor has a claim against one subsidiary in a group it does not mean they can take their action to another member of the group with greater assets)

• Shadow directors – s. 9 (s.9 says the definition of a director is a person who is a director is appointed to that position- if you act as a director then you are a de-facto director. If people habitually act on your commands in the company then you are a shadow director. If you can show the holding company is acting as a shadow director if there is an entity behind them and in relation to who the board of directors acts then you can argue they are a shadow director and this may make you able to argue that the holding company itself is the director and all the legislative duties to the directors will apply to the holding company)

Think about who the shareholders are what kind of control do they have- if they have more than 50% they can make decisions on their own and pass special resolutions. If they have more than 75% they can change the constitution. What director? An employee director or a non employee director? The imposition of costs on third parties. There is no rule that says that imposition of externalities on third parties will lift the corporate veil. The shareholders enjoy limited liability but generally speaking unless they breach their duties directors cannot be liable for the debts of the company.

Case law instances:

• Avoidance of obligations: Gilford v Horne; Jones v Lipman; Briggs v James Hardie; BUT Walkovsky v Carlton

• Sham: Re FG (Films) Ltd (using a company to pretend you are British when everything about the features is American. Dressing up your applicant.)

• Fraud: Hotel Terrigal v Latec investments

• Agency: Smith, Stone and Knight v Birmingham Corp; Spraeg v Paeson

What were the problems with this?

• Under capitalisation/ abuse of limited liability: Walkovsky v Carlton; Briggs v James Hardie; Spraeg v Paeson; Smith, Stone and Knight v Birmingham Corp

What were the problems with this?

• Involuntary creditors

James Hardie press releases (in Reading Materials at 2:1-4)

Australia’s Greatest Corporate Scandal:

• A NSW special Commission of Inquiry into the Medical Research and Compensation Foundation (MRCF) has been investigating the conduct of James Hardie and the adequacy of arrangements established by the company to compensate Australian victims of its asbestos products.

• Until the mid 1980s James Hardie was Australia’s largest manufacturer of asbestos containing products, particularly asbestos cement sheet or fibro.

• Australia had the highest per capita use of asbestos in the world from the 1950s until the 1970s. Almost every third domestic dwelling before 1982 is thought to contain asbestos.

• The first time a warning was put on the products was in 1978.

• Asbestos causes Mesothelioma. It is a disease that occurs in the lining of the lung and it is fatal 9-12 months of diagnosis.

• Australia has the highest per capita incidence of mesothelioma in the world. More than 7,500 have died. More than 500 Australians per year contract the disease and it is expected to peak in 2010. Up to 18,000 are likely to die.

Commission of enquiry exposes Hardie:

• The Hardie Group was structured so that subsidiary entities were the main manufacturers and suppliers of asbestos but the listed parent company had substantial control.

• James Hardie Industries Limited sought to separate themselves from its asbestos liabilities. They stripped the subsidiaries of their assets and left them with the liabilities.

• Hardie established the MRCF with $293 million in assets (the remaining assets of their asbestos producing subsidiaries). The subsidiaries agreed not to sue for the stripping of assets that had taken place by the parent company.

• In 2001 James Hardie got approval from the NSW Supreme Court to establish a new Netherlands based parent company. $1.9 billion was transferred out of Australia. James Hardie solicitors assured the SC that Australian asbestos victims would suffer no prejudice as a result and they could call on the $1.9 billion to meet the claims.

• Australia does not have a treaty with the Netherlands in respect of enforcement of civil judgment obtained in Australia.

• James Hardie cancelled the partly paid shares worth $1.9 billion. Hardie did not alert the court despite assurances and victims could not call on this money. This meant that funds were only available for another 3-4 years and this would result in a shortfall to last for the next 15 years. The compensation owed should be about $2 billion.

The Union position:

• Unions and asbestos support groups on a joint submission with the MRCF have agreed to put forward to the Jackson Commission of Inquiry to agree that no parties will:

  • Support James Hardie tort law reform proposals to reduce asbestos victims right to compensation.

  • Call on James Hardie to provide immediate and unconditional funding to the MRCF.

  • Support the establishment of a James Hardie Special Prosecutor to pursue Hardies for compensation.

  • Agree on a process for streamlinging and reducing legal costs associated with asbestos compensation.

07-35 ASIC commences proceedings relating to James Hardie

• ASIC has commenced civil penalty proceedings in relation to James Hardie, including current and former directors and executives.

• ASIC Chairman Jeffrey Lucy said it was ASIC’s objective to reinforce standards of corporate behaviour vitally important to ensuring public confidence in Australia’s corporate sector.

• They want the court to impose fines and ban individuals as company directors. They want to prove that James Hardie Industries made misleading statements and went against disclosure rules.

• The investigation began in 2004. It has involved 348 billion documents, 72 examinations and 284 notices to obtain evidence.

Redmond [4.45]-[4.65] (for an explanation of the grounds for lifting the corporate veil. Especially Smith, Stone and Knight v Birmingham Corporation)

Piercing the veil of incorporation:

• In Salomon Lord Davey was prepared to identify the company with the totality of its shareholders when they acted as a group and a company has been treated as an enemy alien because of the character of its controllers.

• There are other cases where the courts have ignored the separate personality of the company under the force of some conflicting principle or policy. The categories relate to fraud or improper conduct, agency and limited recognition accorded to the unity of the enterprise of a group of companies under common ownership. The categories are not exhaustive and a case may have more than one category.

• The directors of a company are exposed to personal liability for the debts of the company when they knew or ought to have known of its insolvency under section 588G. Further when the company is a subsidiary or another company, that holding company may also be made liable in relation to those debts where it knew or ought to have known of the state of its financial affairs: section 588V-588X. Directors are also exposed to personal liability for the debts incurred by a corporate trustee where the trustee is not entitled to be fully indemnified by the beneficiaries of the trust.

• Part IVA of the Income Tax Assessment Act 1936 (Cth) is the general anti avoidance provision. It made vendors of shares responsible for the unpaid tax liabilities of their companies. This was a repudiation of Salomon. But it only applied where the vendor shareholders received a price for their shares as to make it probable that tax on the company’s profits would not be paid.

4.50: Gilford Motor Co Ltd v Horne (1933)

Facts:

• The company manufactured and sold Gilford motor cars and parts. It appointed Horne as its managing director. Horne said he would not attempt to entice away any customers of the plaintiff. When Horne’s employment was terminated he opened his own business selling Gilford motor parts. Gilford wanted an injunction to restrain him from enticing away their customers. Horne...