Supreme Court of SA|1991-08-16|Before: Duggan J

GROUP FOUR INDUSTRIES PTY LTD v. BROSNAN and ANOR No. 133 of 1988 Judgment No. 2986 Number of pages - 15 Corporations Law s.556 (1992) 56 SASR 234 [1991] SASC 2986 (16 August 1991)

COURT IN THE SUPREME COURT OF SOUTH AUSTRALIA DUGGAN J

CWDS Corporations Laws.556 - Civil liability of directors for debts incurred by company where reasonable grounds to expect that company will not be able to pay all its debts as and when they become due - discussion as to meaning of various phrases in s.556(1) - Dunn v. Shapowloff (1978) 2 NSWLR 235 and 3 M Australia Pty Ltd v. Kemish referred to - family company - husband and wife directors and shareholders - defences provided for in s.556(2) discussed - Statewide Tobacco Services Limited v. Morley (1990) 2 ACSR 405 referred to - male defendant held liable but action against female defendant dismissed.

HRNG ADELAIDE, 18-28 March, 1991 #DATE 16:8:1991 Counsel for the Plaintiff: Mr N. Strawbridge

Solicitors for the Plaintiff: Baker O'Loughlin Counsel for the Defendants: Mr M Randle Solicitors for the Defendants: Randle and Taylor

JUDGE1 DUGGAN J The two defendants, who are husband and wife, were the only shareholders and directors of a company called Madras Pty Ltd (Madras) which acted as the trustee for the Brosnan Family Trust (the trust). The plaintiff was a supplier of air-conditioning equipment to Madras. Madras was voluntarily wound up on 29th April, 1987 and a liquidator appointed. It is not in dispute that at the date of liquidation the company owed the plaintiff the sum of $71,260.25 which was the total debt resulting from a number of purchases made by the company from the plaintiff from November 1985 to March 1986. Madras was unable to pay its debts at the time of the appointment of the liquidator and the plaintiff claims that the defendants are jointly and severally liable for the amount due to them by virtue of the provisions of s.556 of the Companies (South Australia) Code (the Code). The defendants put forward a counterclaim in their defence, claiming damages for the alleged breach of an agreement that the defendant was to be the sole distributor in South Australia of certain of the plaintiff's products. However the counterclaim was abandoned in the course of the final address of counsel for the defendants. 2. Section 556 of the Code has now been replaced by s.592 of the Corporations Law. At the relevant time the section provided as follows: 556(1) If- (a) a company incurs a debt, whether within or outside the State; (b) immediately before the time when the debt is incurred - (i) there are reasonable grounds to expect that the company will not be able to pay all its debts as and when they become due; or (ii) there are reasonable grounds to expect that, if the company incurs the debt, it will not be able to pay all its debts as and when they become due; and (c) the company is, at the time when the debt is incurred, or becomes at a later time, a company to which this section applies, any person who was a director of the company, or took part in the management of the company, at the time when the debt was incurred is guilty of an offence and the company and that person or, if there are 2 or more such persons, those persons are jointly and severally liable for the payment of the debt. Penalty: $5,000 or imprisonment for 1 year, or both. (2) In any proceedings against a person under subsection (1), it is a defence if the defendant proves - (a) that the debt was incurred without his express or implied authority or consent; or (b) that at the time when the debt was incurred, he did not have reasonable cause to expect - (i) that the company would not be able to pay all its debts as and when they became due; or (ii) that, if the company incurred that debt, it would not be able to pay all its debts as and when they became due. (3) Proceedings may be brought under subsection (1) for the recovery of a debt whether or not the person against whom the proceedings are brought, or any other person, has been convicted of an offence under subsection (1) in respect of the incurring of that debt." 3. The section imposes an important qualification on the general immunity enjoyed by directors and managers of a company from personal responsibility for the debts of their companies. This development began with s.303(3) of the Companies Act, 1962 and has continued with s.592 of the Corporations Law which is almost identical to s.556 of the Code. S.556 went further than s.303(3) of the earlier Act which did no more than provide for an offence if it appeared in the course of a winding up that an unreasonable debt had been incurred. S.556 permitted recovery of the debt from any person who was a director or manager and came within the objective test set out in subsection (1). This liability was subject to certain limited defences available to the defendant by virtue of subsection (2). The legislative scheme is better understood when these provisions are read in conjunction with other sections of the Code (eg. ss.229, 269 and 270) which imposed duties and a standard of care upon directors. As Kirby P observed in Metal Manufacturers Pty Ltd v. Lewis (1988) 13 NSWLR 315 at p 319: "That scheme requires of (relevantly) directors (of whom there must be at least two) higher levels of attention to the affairs of the corporation and its dealings with the outside world than was the case in the past." 4. The companies to which s.556 applies (in view of the almost identical current legislation I shall use the present tense) include a company which has been wound up or is in the course of being wound up (s.553(1)). When a company comes within either of these categories at the time a debt is incurred or at some later time, a director or manager of the company will be personally liable for that debt if the criteria referred to in either sub-paragraph s.556(1)(b)(i) or s.556(1)(b)(ii) are satisfied. Under s.556(1)(b)(i) attention is directed to the company's capacity to pay those debts existing immediately before the particular debt under consideration is incurred; s.556(1)(b)(ii) requires that debt to be taken into account in assessing capacity to pay. In civil proceedings the plaintiff is required to establish its case under s.556(1) on the balance of probabilities (s.556(3A)). 5. The time for assessing the capacity of the company to pay its debts is immediately before the particular debt under consideration is incurred. In the circumstances of the present case I am of the view that the individual debts were incurred at the time each order was fulfilled by delivery of the stock. This is when the obligation to pay arose. A separate assessment has to be made in the case of each debt as at the time it was incurred. The time at which each debt was due is relevant to another aspect of the legislation which I will deal with shortly. 6. The words "reasonable grounds" which appear in both sub-paragraphs of s.556(1)(b) require a consideration of objective criteria and an assessment as to reasonableness. The state of knowledge of the particular defendant and any assessment he may have made as to the ability of the company to pay its debts are irrelevant considerations insofar as this subsection is concerned. It is for the court to make a judgment on the basis of the facts as they existed at the relevant time and without the benefit of hindsight. It should also be borne in mind that the word "expect" goes beyond a mere hope or possibility (Dunn v. Shapowloff (1978) 2 NSWLR 235 per Mahoney JA at p 249). Although the objective assessment is to be made immediately before the debt is incurred, it is the company's capacity to pay all its debts when they become due which must be considered. I respectfully agree with the observations of Foster J in 3M Australia Pty Ltd v. Kemish 10 ACLR 371 on the question as to when a debt becomes due: "I am satisfied that a debt does not necessarily become 'Due', within the meaning of the section, upon the date originally stipulated for its payment. I consider that it is proper to take into account arrangements made by the company with the creditor for extended time for payment, even where such arrangements would not be

contractually binding upon the creditor. Even where there is no express arrangement for extension of credit beyond the time originally stipulated, I think it appropriate to take into account in determining whether the section has been satisfied, whether a course of dealing between the company and a particular creditor would reasonably lead to an expectation on the part of the defendant that some reasonable extension of period of credit would be allowed by the creditor as a matter of grace. Clearly, nice questions of fact must be involved in such considerations and the question of whether the 'Due' date for payment of a company's debt has been extended, will depend upon the precise circumstances relating to the individual debt, and the particular creditor." 7. The defendants argued that the plaintiff had not established its case under s.556(1). In addition, they argued that they had established the defence provided for in s.556(2)(b) and the female defendant also contended that each debt was incurred without her express or implied authority or consent (s.556(2)(a)). The onus is on a defendant to prove by way of defence the matters referred to in s.556(2) on the balance of probabilities. I will return to consider this subsection in more detail when I come to discuss the evidence relating to these specific defences. 8. The defendant Mr Brosnan went into business on his own account in 1976, having been employed in the air conditioning industry for some years. He and his wife operated the business under the name Brosnan Industries. Eventually it was decided that the business should be conducted by the Brosnan Family Trust and Madras was incorporated so as to act as trustee. The company was incorporated on 30th June, 1980. Mr Brosnan was responsible for the everyday running of the business. Mrs Brosnan assisted from time to time, but she claims to have known almost nothing about the financial aspects of the business. Throughout most of the period during which Madras was operating, its principal role was to act as a distributor of air conditioning equipment supplied by the plaintiff which had its head office in Sydney. 9. It is necessary to say something about the history of the plaintiff company. In May 1983 it was taken over by Bradway Engineering Pty Ltd (Bradway). Both companies retained their separate corporate identities, but were managed by the same personnel. Mr Graham Baker was a director of Bradway and he became a director of the plaintiff company. David Leeman, one of the directors of the plaintiff company at the time of the takeover, was appointed to the position of sales and marketing manager of the new group. In March 1985 control of the plaintiff company passed into the hands of a New Zealand company, Temperzone Holdings Ltd. Mr Baker was retained as a director and general manager of Bradway and the plaintiff company. Madras continued to deal with these companies. 10. The evidence discloses that the business originally operated by Brosnan Distributors and subsequently acquired by Madras was in financial difficulty at least from the time Madras was incorporated. Immediately before the incorporation the liabilities of the business exceeded its assets by over $30,000.00. After the trust was created goodwill was shown in the balance sheet of the trust as an asset valued at $34,800.00 This entry was made following an estimate made by Mr Brosnan. Although there was a good deal of evidence as to the method by which the amount was calculated, I am of the view that its inclusion in the accounts is of little significance. It was not listed as an asset by Mr Brosnan in the Summary of Affairs prepared for the liquidation proceedings and it is irrelevant to the consideration as to whether the company was able to pay its debts while continuing to trade. I am satisfied that it was inserted in the journal as an asset to balance the deficit to which I have referred. This deficit was in part the result of the difference between creditors ($52,348.02) and debtors ($25,373.93). If the value put upon goodwill were ignored it was the view of Mr Raphael, an accountant called by the plaintiff, that the company was insolvent from the time it commenced its activities. 11. It is also clear that from the time of its incorporation, the company was reliant solely upon funds from sales to pay its creditors. Mr Brosnan conceded that this was the case. It had no assets which could be realised for this purpose or which could be used as security for borrowings. The evidence establishes that throughout its entire existence the company struggled to meet its financial commitments. Apart from accepting the evidence of Mr Baker on this aspect I also rely on the trading accounts and balance sheets of the company and the trust. The following table prepared from the accounts of the trust gives some indication of the precarious existence of the business. YEAR ENDED SALES NET PROFIT/ EXCESS

30th JUNE LOSS ASSETS 1981 346,328 $ 4,328 $140 1982
$478,544 $ 3,734 $120 1983 $449,861 $ 165 $118 1984 $497,030 $17,085 $2,623 1985 $556,198 $ 3,179 (loss) $1,212 (deficiency) 1986 $323,382 $35,416 (loss) $32,815 (deficiency) 12. As I have pointed out, the value placed upon goodwill, namely $34,800, was included as an asset in the balance sheet of the trust from the date of incorporation of the company and the creation of the trust. However, in accordance with the views I have expressed above, the sum of $34,800 should be deducted from the amounts shown in the last column. This would mean that, at least at the end of each financial year, the liabilities of the company and the trust exceeded their assets. Bearing in mind that the relevant debts were incurred in the 1986 financial year, it is also important to have particular regard to the trading losses recorded in the financial years 1985 and 1986. 13. It is not in dispute that in the months of November and December 1985 and January, February and March 1986 Madras purchased air conditioning equipment from the plaintiff which resulted in a debt totalling $71,260.25. Particulars of the individual accounts are as follows: Invoice Date Amount 7.11.85 $ 8,556.00 12.11.85 $ 8,217.00 19.11.85 $ 2,993.00 29.11.85 $ 4,474.80

$ 1,566.40 $ 1,733.60 $ 3,669.60 $ 1,432.20 9.12.85
$ 4,509.80 16.12.85 $ 1,842.00 18.12.85 $ 4,474.80 20.01.86 $ 7,458.00 29.01.86 $ 103.95 31.01.86 $ 2,304.80 $ 3,141.60 10.02.86 $ 4,901.60 $ 2,750.00 18.02.86 $ 1,491.60 $ 1,630.20 17.03.86 $ 2,983.20 21.03.86
$ 352.00 14. The statements of account forwarded by the plaintiff show the amounts outstanding from the commencement of the 1985 financial year to the month when the last purchase was made. MONTH AMOUNT OUTSTANDING July 1985 $ 86,563 August 1985 $ 78,299 September 1985 $ 66,070 October 1985 $ 90,411 November 1985 $ 92,327 December 1985 $ 89,154 January 1986 $ 84,835 February 1986 $ 75,925 March 1986 $ 71,260 15. In the light of the figures set out in the first table, particularly those for 1985 and 1986, and in the absence of any assets or potential borrowing which might be used for the payment of debts, it is not surprising that Mr Brosnan conceded in evidence that he could not have kept up to date with payments if the plaintiff had insisted on its usual trading terms of payment within 30 days. The far more contentious issue is whether there was a relaxation of those terms in favour of Madras. According to Mr Brosnan there was an agreement to that effect between himself and representatives of the plaintiff. The agreement was denied by Mr Baker. It is necessary, therefore, to consider the conflicting accounts in more detail. 16. A letter (exhibit P15) was sent by the plaintiff to the defendants' address some time before Bradway assumed control of the plaintiff company. The letter was undated, but in it the defendants were advised that an account had been opened in the name of Brosnan Distributors and that - "Terms of trading are strictly 30 days NETT." On 18th November, 1985 the plaintiff forwarded another letter to the defendants advising them once again of the terms of trading. The plaintiff's witnesses explained that the 30 days was calculated from the end of the month in which the invoice was issued, so that in some circumstances the time for payment was as much as 50 or 60 days. 17. There is no doubt that Mr Brosnan was aware of these usual terms of trading, but, according to his evidence, he reached an agreement with the plaintiff enabling the business to trade on more favourable terms. He claimed that until 1985 he was not obliged to pay for equipment purchased from the plaintiff until he had sold it. Then in about January 1985 Mr Leeman rang him and said that he was instructed by his superiors to bring Brosnan "more into line with the Bradway trading terms of 30 days". Leeman also said that there was a possibility that the Bradway/Group Four group was going to be taken over by the New Zealand company. Brosnan said that he and Leeman reached an agreement "that instead of picking out individual invoices we would try and round off a set amount, either by weekly payment or fortnightly payment based on what we would normally expect to be your annual turnover of the product". He said he thought they came to an agreement that the amounts would be paid fortnightly and that he recalled a figure "around about the $10,000 mark". He was asked: "If it were to vary from $10,000 what factors would lead to its not being exactly $10,000?" Brosnan replied: "Purely at any one time it can really only be cash flow." 18. Mr Leeman was not called by either side, but for reasons which I will explain shortly, I reject Mr Brosnan's evidence that a compromise of this nature was agreed upon. Leeman left the company in 1985. According to Mr Brosnan he left towards the end of the year, but I prefer Mr Baker's evidence that the departure took place in mid-1985. Mr Brosnan stated that after Leeman left, Mr Baker rang and said that he had taken over where Leeman had left off and that one of his more important tasks was to keep accounts in order. To this end he was anxious to get the Madras account back to a 30 day payment. Mr Brosnan said in evidence: "We spoke of the regular $10,000 that we were doing. He wanted to do better than that and I couldn't see my way clear to do better than that.... I said I can only do what I have been doing in the past." According to Brosnan, Baker said he would refer the matter to the management. Baker rang later to say: "The arrangement stands and we will continue to supply." Later in his evidence Mr Brosnan said the agreement was to pay $10,000 a week (pp.406 and 408) but that this was "subject to cash flow". He agreed under cross-examination that if there was no cash flow at any particular time "then he wouldn't get his money". 19. Mr Baker painted quite a different picture of the dealings between his company and Mr Brosnan. He said that as long as he could remember Brosnan's account was "delinquent". He said the payments were "dragged out of him by any means I could and if that meant that I begged him for some amount of dollars this week, I would do so". He said it got to the stage where he was ringing Brosnan weekly asking him for money. Mr Baker specifically denied the existence of the agreement claimed by Mr Brosnan. He stressed that at no time did he agree to a relaxation of the 30 day terms; the lump sum payments were accepted but this method of payment was not condoned. 20. I have no hesitation in accepting Mr Baker's version on this issue. He was an impressive witness, straightforward in his evidence. His version was in harmony with other relevant evidence which I accept. As a result of the takeover involving the plaintiff company a concerted effort was made to bring accounts into order. Particular efforts were made with the Brosnan (Madras) account. In the light of these efforts and the eventual withdrawal of supply to Brosnan early in 1986 I regard it as extremely unlikely that either Baker or Leeman would have reached an agreement with Brosnan which amounted to not much more than a preparedness to accept what Brosnan could afford from time to time. I am also constrained to say that I found Mr Brosnan to be quite an unimpressive witness. His version on this crucial aspect was vague in examination-in-chief and, when laid bare in cross-examination, the full extent of its weaknesses became apparent. I find that Mr Baker's telephone calls complaining about the account were far more frequent than Mr Brosnan was prepared to concede. It should also be pointed out that those $10,000 payments which were made (and there were a number of them) were quite irregular and, in themselves, indicative of the company's inability to pay over a substantial period of time. In the result, therefore, I find that the plaintiff at no stage varied its stipulation that Madras was to pay in accordance with the usual terms of trading. I also find that Mr Brosnan was not given the impression that this was so. Mr Baker made the plaintiff's insistence on payment within the usual trading terms quite clear to Mr Brosnan. I have reached the conclusion, therefore, that Madras was required to pay each account 30 days after the expiry of the month in which the invoice was rendered. As I have pointed out, on Mr Brosnan's own evidence the company was unable to abide by these terms. 21. I should add that, although the plaintiff was the major supplier to Madras and therefore the major creditor, there was clear evidence of lump sum payments to a number of other creditors. Mr Brosnan's explanation as to how these payments came about (evidence p.415f) was most unsatisfactory and I have no doubt that the payments were made in this manner because the company could not pay its debts as they fell due. 22. In reaching these conclusions I have taken into account the comments made by Foster J in Kemish's case to which I have referred. I have had regard to the consideration that a course of dealing between supplier and purchaser may lead to an understanding on the part of the purchaser that trading terms have been or may be relaxed. Accordingly continued supply in the face of a history of payments outside the 30 day period is a factor which I have considered in the present case. But I have no hesitation in rejecting that there was such an understanding in the present case. 23. It follows that the plaintiff has made out its case against both defendants under s.556(1). Immediately before each debt in the months of November and December, 1985 and January, February and March, 1986 was incurred there were reasonable grounds to expect that Madras would not be able to pay all its debts as and when they became due. I should add that in making these findings I have borne in mind "the gravity of the fact to be proved" (Rejfek v. McElroy (1965) 112 CLR 515 at 521). 24. The next step is to determine whether either defendant has made out any of the defences referred to in s.556(2). I am convinced that Mr Brosnan has not established a defence under either limb of s.556(2)(b). Much of what I have already said is relevant to this finding. Mr Brosnan was the principal of a small family business which he had operated over a period of years, both before and after it was incorporated. The financial structure of the business was uncomplicated. At all times he must be taken to have been possessed of a reasonably accurate picture of the major factors relevant to the financial state of the business, in particular, sales and amounts owing by debtors and to creditors. The monthly sales figures were recorded in one of the books of the company (exhibit D25). The amounts owing to creditors were easily ascertainable. The major creditor was the plaintiff and the purchases of air conditioning equipment did not result in a large number of invoices which might have made accounting more difficult. At any time Mr Brosnan could have quite easily and quickly ascertained the precise financial situation of the company. His familiarity with the business also made him aware of seasonal variations in trade. 25. I have considered the possibility that the comparatively favourable trading in the 1984 financial year may have given him some confidence. However there was a clear downturn in the 1985 and 1986 years. I am convinced that at least by October 1985 Mr Brosnan would have recognised the signs of the serious downturn which was to continue until the company went into liquidation. The total sales figures for the first six months of the 1985 financial year reveal a sharp drop in sales when compared with the figures for the same period in the previous year. In view of his experience in previous years he would also have appreciated the potential effect of this downturn on the company's ability to repay its creditors. It is not without significance that in about July 1985 Mr Brosnan spoke to Mr Philipson about profit margins. Mr Philipson, who was visiting Adelaide at the time, said that the discussion related to "how we could improve his margin so that he could make a living, essentially have a business .... his attitude was that the margin allowed meant he wasn't making an adequate return or profit margins." Then, according to Mr Brosnan, he had a meeting with Mr Lee in about December 1985. Mr Brosnan said in evidence: "...it was at that meeting that I said to Michael Lee that our sales are falling off, they are noticeably falling off, more so than

an out of season precedent that I had experienced, and it was at that meeting that I suggested to him that it may well be worth the idea of us getting together and me bringing my customers with me and joining forces of the Bradway, Group Four group. Q. You mean to work for them? A. That's right." 26. In the light of all of this evidence, far from being satisfied that a defence under s.556(2) has been established, I am of the view that the contrary position has been proved on the balance of probabilities, namely, that Mr Brosnan did have reasonable cause to believe at the time each relevant debt was incurred from November to late March 1985 that the company could not pay all its debts when they became due. 27. The application of s.556(2) to the case of Mrs Brosnan gives rise to some difficult questions of interpretation. Before dealing with them it is necessary to state my findings as to her role in the company. She is a dressmaker by trade who has had very little business experience. In 1984 she commenced work as a shop assistant at John Martin's Store and was still employed there at the time of giving her evidence. Mr Brosnan said that until about 1983 (he could not be any more specific) the business was conducted from an office in his house. Then it was moved to a warehouse and office. When he left the office he would switch the telephone over to the house. His wife said that she worked between 18 and 20 hours per week for the company, but she said that her role was restricted to answering the telephone and accepting deliveries when they were made to the house. Sometimes she did the banking. She said she did not have any involvement with the creditors or debtors of the business. Each year she signed the documents associated with the annual return of the company. Sometimes she signed cheques but this did not occur very often. Mr Brosnan was not formally appointed as managing director, but it is clear that he assumed complete de facto control of the business. I accept Mrs Brosnan's account of her involvement in the business of the company. 28. The first question which arises is whether Mrs Brosnan has established that the debts were incurred without her express or implied authority or consent (s.556(2)(a)). Counsel for the plaintiff submitted that in considering this defence as well as the further defence provided for in s.556(2)(b) I should adopt the construction of the Act to be found in the carefully reasoned judgment of Ormiston J in Statewide Tobacco Services Limited v. Morley (1990) 2 ACSR 405 (see also Commonwealth Bank of Australia v. Friedrich and Others (Supreme Court of Victoria, unreported judgment of Tadgell J delivered 3rd July, 1991)). In Morley's case the defendant was a company director who, despite the fact that she took no effective part in the management of the company, was nevertheless held responsible under s.556 of the Code for debts which the company had incurred. The company operated a small family business which had been controlled by the defendant's husband. When he died the business was taken over by the defendant's son who, although he was not appointed as managing director, exercised similar powers. The defendant had very little knowledge of the everyday operations of the business. 29. After observing that in the course of the day to day business of an ordinary trading company most trading debts will not be incurred by either the board or an executive director, his Honour then went on to consider whether a director could show that a debt of this kind was incurred without his or her express or implied authority or consent when he or she was unaware that the debt was being incurred. This led him to consider the meaning of "implied authority" in the subsection. 30. Ormiston J rejected the view expressed by McHugh JA in Lewis's case that the use of the term "authority" in s.556(2)(a) indicates that the paragraph is concerned with a director or participant in the management who confers a right on somebody to incur a particular debt. Ormiston J concluded that the word "authority" had a wider meaning. He said: "In the context of this section, which requires proof of want of 'authority', the authority in question is that which is conferred by the act of one or more directors, whether participating in the grant of the company's authority as a member of the board of directors or in his role as managing or executive director. If a director did not so participate in the conferring of authority, whether express or implied, only then can it be said that the particular debt was incurred 'without his express or implied authority'. To conclude otherwise would ignore the realities of the day-to-day management of companies." (2 ACSR 405 at p.419) 31. His Honour went on to find that the defendant was not entitled to rely upon the defence provided for in s.556(2)(a). He said: "It is sufficient to repeat that she and her daughter agreed in 1979, albeit informally, with their co-director Mr Ian Morley that he should continue to manage the company on their and its behalf. The general authority so conferred was sufficient to authorise the incurring of the debts which the plaintiff now seeks to enforce against the defendant pursuant to s.556. It likewise follows that those debts were incurred with her implied authority within the meaning of the paragraph." (2 ACSR 405 at p.426) (my emphasis) 32. Mahoney JA, the other member of the majority of the court in Lewis's case, dealt with the argument that where a director consents to the appointment of another as managing director and/or allows him to remain as such, what the managing director does has the authority or consent of that director. His Honour rejected this argument noting that the evidence did not disclose how the defendant's husband was appointed and whether the defendant had power to remove him. But his Honour also dealt with the principle underlying the argument and this led him to comment on the nature of the role of a managing director. He said: "When a director is appointed to the office of managing director, prima facie he derives his authority to do what he does from that office. When, as I shall assume to be the case here, his office is provided for by the articles of association, he derives authority to do what he does from articles of association and the fact that he has been appointed to the office created by them. It is not necessary for present purposes to consider whether the authority which he derives from that office is, in principle, part of the authority committed to the board of directors as such or whether his authority to do what a managing director may do derives, as it were, not through the board of directors but directly from the company. Whatever be the position in that regard, his authority derives not from authority or consent given by the directors, but from the fact that he has been appointed to the office. This is of significance in the relationship between a managing director and the board of directors. In principle, he may do what he does notwithstanding that the directors do not positively assent to it. He may exercise his powers notwithstanding that some or all of the directors do not agree with what he does. A fortiori, he may act where some of the directors do not authorise or consent to what he does but disapprove of it. His authority continues unless and until, in accordance with the articles of association or otherwise in an effective manner: see, eg. Carrier Australasia Ltd v. Hunt [1939] HCA 21; (1939) 61 CLR 534; his office is terminated or, in accordance with the powers of the company or of the board, action is taken to place restrictions upon what he may do." ((1988) 13 NSWLR at p.325) Ormiston J considered that the fact that Mr Lewis was managing director was crucial to the reasoning of Mahoney JA and pointed out that in Morley's case the defendant's son was not a managing director. 33. In resolving the difficult questions of interpretation raised by this section, I think there is considerable advantage to be gained from contemplating the purpose of the provisions. Although, as I have already stated, s.556 is to be viewed as one of a number of sections concerned with ensuring responsible control and management of corporations, it is nevertheless directed towards specific conduct described in the marginal note as "Offences relating to incurring of debts or fraudulent conduct". An offence involving fraudulent conduct is provided for in s.556(5). But it is of some importance to note that, apart from enabling recovery of debt, the section attaches criminal liability punishable by imprisonment to the same conduct which allows for the civil remedy. Elsewhere in the Code dishonesty is punishable by imprisonment (s.229(1), s.229(3) and s.229(4)), but in the case of failure to exercise reasonable care and diligence (s.229(2)) the punishment is limited to a fine. 34. Although under s.556(1) liability is determined according to an objective assessment, harshness is ameliorated by defences which take into account subjective elements. I understand the reliance which Ormiston J places upon the manner in which directors are ordinarily required to act and I accept his comment that more often than not debts will be incurred without the express authority of the board or executive director. However, the defences created by s.556(2) give rise to subjective considerations, namely, the actions and state of mind of the defendant. Emphasis is placed upon the particular debt. It is far from clear that a general authority for others to incur debts excludes the defence provided for in s.556(2)(a). The existence of a severe penal sanction reinforces my view that a narrower interpretation is called for. This interpretation would still leave scope for debts incurred by implied authority. To say that the Code contemplates authority or consent with respect to a particular debt is not to say that precise details of that debt must be known by the defendant. In Heide v. Lester (1990) 3 ACSR 159 O'Bryan J found a defendant liable under s.556 in circumstances in where she was engaged as a receptionist and secretary in the company for four days a week, spoke directly with creditors about their debts, was privy to invoice statements and aware of the order system and knew that debts were incurred by the company with creditors on a day-to-day basis. In these circumstances she was placed in a position to make the assessments referred to in the section. 35. However circumstances such as that must be contrasted with the facts of the present case. Mrs Brosnan had no knowledge that the debts under consideration were incurred. She knew no more than that her husband, as a general practice, placed orders for equipment which he sold to other persons. In the view that I take of the meaning of the section she did not expressly or impliedly authorise the debts or consent to them being incurred. It is my view, therefore, that the defence under s.556(2)(a) has been established on the balance of probabilities. 36. Finally I turn to the defence raised by Mrs Brosnan under s.556(2)(b). I have already summarised some of her evidence. In addition to her lack of familiarity with the day to day operations of the business, I accept that she had very little knowledge of the true financial state of the company throughout the relevant period. She knew in a very general way that "the business had some problems". Although she could not say precisely when she first became aware of that, she said that it could have been around Christmas 1986. 37. The proper construction of s.556(2)(b) also received close attention from Ormiston J in Morley's case. The defendant argued before his Honour that the reasoning of Wilson J in interpreting s.303(3) of the Companies Act, 1961 (N.S.W.) in Shapowloff v. Dunn [1981] HCA 21; (1981) 148 CLR 72 was relevant to the proper interpretation of the paragraph. S.303(3) provided as follows: "If in the course of the winding up of a company it appears that an officer of the company who was knowingly a party to the contracting of a debt provable in the winding up had, at the time the debt was contracted, no reasonable or probable ground of expectation, after taking into consideration the other liabilities, if any, of the company at the time, of the company being able to pay the debt, the officer shall be guilty of an offence against this Act. Penalty: Imprisonment for three months or $200.00." 38. Wilson J expressed the following view as to the meaning of the section: "The prosecution must prove beyond reasonable doubt that at the time of contracting the debt the defendant himself had no expectation, reasonably grounded in the whole of the circumstances then existent as he knew them, of being able to pay the debt. It will be seen that the test involves a blending of subjective and objective considerations. The test of reason imports an objective standard, but it is to be applied to the facts as known to the defendant. Given this construction of the provision, I am unable to accept the submission of the appellant. The defendant himself cannot be the arbiter of the reasonableness or otherwise of an expectation that he would be able to meet the debt. However, it is a question of his expectation, and whether that expectation is objectively reasonable." Carruthers J in Pioneer Concrete Pty Ltd v. Ellston (1985) 10 ACLR 289 and Foster J in Kemish's case both treated this interpretation as a guide to the meaning of s.556(1)(b) in the later legislation. 39. However in Metal Manufacturers Ltd v. Lewis (1986) 4 ACLC 739 at p 748 Hodgson J at first instance said: "... the view that I have come to and which is consistent with the other recent decision to which I will refer, is that in deciding whether or not a defendant has 'reasonable cause' within sec.556(2)(b), one can have regard to facts and circumstances actually known to the defendant, and also facts and circumstances which the defendant ought to know, having regard to the defendant's position in the company and the duties associated with that position. This view received some support from the case of In re a Solicitor (1945) 1 KB 368, in which Scott LJ delivering the judgment of the English Court of Appeal said at p 371: "The word 'reasonable' has in law the prima facie meaning of reasonable having regard to those circumstances of which the actor, called on to act reasonably, knows or ought to know." That case, of course, concerned a requirement on a person to act reasonably. However, I think 'reasonable' has the same prima facie meaning in relation to the question whether or not a person has reasonable cause to expect something, particularly where that person is seeking to deny it by reference to his own lack of knowledge." 40. Ormiston J accepted this line of reasoning in the following passage: "In the end the critical word in the paragraph is 'reasonable'. Whereas proof of the want of 'reasonable and probable ground of expectation' that a company could pay a debt (in s.303(3)) appeared to require a consideration of the facts actually known to the defendant, the present section requires proof by way of defence that the defendant had no reasonable cause to expect that the company could not pay its debts as they fell due. The former provision looked to proof, beyond reasonable doubt, that a company, with the knowledge of the defendant, had incurred a particular debt, as to

which it then had to be shown that there was no reasonable or probable ground of expectation that the debt would be paid. The defence in para (b) is more general. It assumes proof by the plaintiff or prosecution of the matters set out in subs (1) and then requires proof by the defendant of absence of expectation of insolvency, to use a compendious expression. Because the defendant must prove a negative and one related to the ability of the company generally to pay its debts as and when they become due, the question of the director's reasonable cause of expectation is not related to a specific debt but to the financial position of the company generally. Thus the issue is directed to what the director might reasonably know and understand of the company's general financial position at the relevant time. In the light of the various duties now imposed upon the directors, it would not appear unreasonable that they should apply their minds to the overall position of the company. In other words, a defendant is not entitled to say that he or she was told a minimal number of facts about the company's

financial affairs but chose to ignore the possibility of other facts, or at least failed to inquire further as to other relevant facts. What is reasonable, therefore, is related in part to the extent of the inquiries that the director has made and should have made about the company's solvency. A director should not in those circumstances be entitled to hide behind ignorance of the company's affairs which is of his own making or, if not entirely of his own making, has been contributed to by his own failure to make further necessary inquiries. On the other hand directors are not required to have omniscience. It is not yet assumed that directors shall apply themselves full-time to the company's business. There is still a place for part-time and advisory directors. Directors are entitled to delegate to others the preparation of books and accounts

and the carrying on of the day-to-day affairs of the company. What each director is expected to do is to take a diligent and intelligent interest in the information either available to him or which he might with fairness demand from the executives or other employees and agents of the company." 41. In my view the words "cause to expect" must refer to the knowledge of the defendant, however acquired. The word "reasonable" imports objectivity into the test, but its purpose is to qualify "cause". Wilson J's construction is typical of the approach taken in many cases dealing with phrases such as "reasonable cause" and "reasonable suspicion". In those cases the enquiry commences with the facts as the particular individual believed them to be. The test of reasonable cause or suspicion is then applied to those facts. Once again the fact that the section imposes a penal sanction is also relevant. Generally speaking criminal conduct is not founded upon facts which the defendant ought to have known. In my view a court should not interpret legislation as providing for liability on such a basis unless its wording is clear and unambiguous. 42. Furthermore I have reservations about relying, as Ormiston J did, upon other provisions of the Code concerned with the more general duty of a director to take care in the exercise of his powers in interpreting the word "reasonable" in s.556(2)(b). Rather it seems to me that the section is dealing with more specific conduct which has its place in a section which also contains provisions relating to fraud. In my view those cases in which there has been some advertence to a particular debt and the inability of the company to pay its debts generally are singled out. I have reached the conclusion, therefore, that the secondnamed defendant has made out the defence under s.556(2)(b) in addition to that provided for by s.556(2)(a). 43. In the result there will be judgment for the plaintiff against the firstnamed defendant in the sum of $71,260.25. The evidence falls short of supporting the assertion in the Statement of Claim that the parties agreed that invoices unpaid after a period of 30 days would attract interest at the rate of 2% per month. That evidence consisted principally of printed conditions on the reverse side of a general circular to customers (P12). Accordingly I disallow the claim for interest based on the alleged agreement. The action against the secondnamed defendant will be dismissed.

GROUP FOUR INDUSTRIES PTY LTD v. BROSNAN and ANOR No. 133 of 1988 Judgment No. 2986 Number of pages - 15 Corporations Law s.556 (1992) 56 SASR 234 [1991] SASC 2986 (16 August 1991)

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Judgment (13 paragraphs)

GROUP FOUR INDUSTRIES PTY LTD v. BROSNAN and ANOR No. 133 of 1988 Judgment No. 2986 Number of pages - 15 Corporations Law s.556 (1992) 56 SASR 234 [1991] SASC 2986 (16 August 1991)

Cases Cited (6)