Supreme Court of SA|2001-03-29|Before: Mullighan J

SHEAHAN AS LIQ SA SERVICE STATIONS v VERCO & HODGE No. SCCIV-96-1303 [2001] SASC 91 (29 March 2001)

SA Service Stations owned and operated a number of service stations in South Australia. The purchase and operation of two of the Company's businesses had been in substantial part financed by the Bank of Singapore and the ANZ Bank. The credit had been secured by a charge over the assets of the Company and the personal assets of the Managing Director. Further finance had been sought and obtained in return for a shareholding from Verco and Hodge. Both became non-executive Directors of the Company but were not active participants in the management of the Company. The Company went into liquidation in July 1992 when the creditors sought to enforce their mortgages. Consideration of the duty of care owed by non-executive directors order both the common law and statutory provisions - comparison of obligations - whether Verco and Hodge owed a duty to the Company. Consideration of obligations owed by non-executive directors to the Company - relationship between the standard expected under the common law and the statutory provisions - whether Verco and Hodge breached their duty of care by failing generally to involve themselves and inquire into the operation of the company. Company demonstrated to be insolvent as at June 1991. Analysis of whether the Company was insolvent at an earlier time in 1991 or 1992 and permitted to incur debts by the failure of the Directors to act - relevance of capacity of the Company to trade profitably - relevance of insolvency case law under statutory scheme to assessment at common law. Whether if the Directors had acted that nevertheless such action would not have reduced the Company's losses. Relevancy of inaccuracies in a financial record to admissibility of that document under the business record provisions in s 45a - purpose to which such a document may be put. ``Insolvency''

Corporations Law s 232(1); s 232(4), referred to.
Daniels v Anderson (1995) 37 NSWLR 438, applied.
Permanent Building Society (In Liq) v Wheeler & Ors (1994) 14 ACSR 109;
Daniels v Anderson (1992) 10 ACLC 993;
Duke Group (In Liq) v Pilmer & Ors [1998] SASC 6529; (1998) 144 FLR 1;
Duke Group (In Liq) v Pilmer & Ors (No 2) [2000] SASC 418;
Walker v Winborne and Others [1976] HCA 7; (1975) 137 CLR 1;
Kinsela and Anor v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722;
Lyford and Anor v Commonwealth Bank of Australia [1995] FCA 1261; (1995) 130 ALR 267;
Winkworth v Edward Baron Development Co Ltd and Ors [1987] 1 All ER 114, considered.
Corporations Law s 231(1) s 232(4); s 258; s 289; s 292; s 293; s 294; s 297; s 298; s 301, referred to.
Daniels v Anderson (1995) 37 NSWLR 438, applied.
Capricorn Society Ltd v Linke & Ors (1996) 130 FLR 19, discussed.
Jones v Dunkel and Anor [1959] HCA 8; (1959) 101 CLR 298;
Francis v United Jersey Bank 432 A 2d 814 (NJ 1981);
Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115;
Metal Manufacturers Pty Ltd v Lewis (1988) 13 NSWLR 315;
Morley v Statewide Tobacco Services Ltd [1993] VicRp 32; [1993] 1 VR 423;
Walker v Winborne and Others [1976] HCA 7; (1975) 137 CLR 1;
Kinsela and Anor v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722;
Lyford and Anor v Commonwealth Bank of Australia [1995] FCA 1261; (1995) 130 ALR 267;
Winkworth v Edward Baron Development Co Ltd and Ors [1987] 1 All ER 114, considered.
Corporations Law s 232(1); s 232(4); 588G; s 592, referred to.
Rees v Bank of New South Wales [1964] HCA 47; (1964) 111 CLR 210;
Queensland Bacon Pty Ltd v Rees [1966] HCA 21; (1965) 115 CLR 266;
Sandell v Porter and Anor (1966) 115 CLR 666;
Standard and Chartered Bank of Australia v Antico and Ors (1995) 131 ALR 1, applied.
Powell & Duncan v Fryer, Tonkin & Perry [2000] SASC 97, considered.
Evidence Act 1929 (SA) s 45a, referred to.

Plaintiff: JOHN SHEAHAN (AS LIQUIDATOR FOR SA SERVICE STATIONS)

Counsel: MR M BLUE - Solicitors: COSOFF CUDMORE AND PARTNERS

Defendants: MICHAEL LISTER VERCO AND ROBERT VERE HODGE

Counsel: MR J WILKINSON WITH MR A DAL CIN - Solicitors: COWELL CLARKE

Judgment No. [2001] SASC 91

JOHN SHEAHAN AS LIQUIDATOR OF SA SERVICE STATIONS PTY LTD (IN LIQUIDATION) AND SA SERVICE STATIONS PTY LTD (IN LIQUIDATION) v VERCO & HODGE

1 MULLIGHAN J This action is brought by the plaintiff, Mr Sheahan, in his capacity as the liquidator of the plaintiff, SA Service Stations Pty Ltd (In Liquidation) ("the Company") against the defendants, Mr Verco and Mr Hodge, for losses alleged to have been sustained by the Company during a period when they were directors of the Company.

2 It is necessary to set out some matters of background.

3 The Company was incorporated in this State in 1977 under another name. The issued shares of the Company were acquired by a Mr Linke and his accountant, Mr Veitch, in 1984 and the name of the Company was changed to its present name on 6th June 1984. Mr Linke and his wife became sole directors of the Company on 1st July 1984. Thereafter Mr Linke was the only executive director of the Company and occupied, in substance, the position of managing director and chief executive officer. He ceased to be a director on 28th May 1992.

4 In about March 1988 two service stations were acquired by the Company in metropolitan Adelaide, being BP Service Stations at Glandore and Glenunga and finance for that purpose was obtained from Australian and New Zealand Banking Group Limited ("the ANZ Bank") which secured the loan by taking a charge in the form of a debenture over all of the assets and undertakings of the Company. The loans were in the nature of an overdraft and bill facilities. Initially the bill facility was for $300,000 at an interest rate for a term of 30 days. In April 1988 the Company acquired a third business which was a perfume trading business with the name "From Paris with Love" and further loans were obtained for that purpose, being an overdraft facility of $60,000 and a bill facility of $100,000.

5 The Company did not operate these businesses profitably and incurred losses. It is unnecessary for present purposes to set out the financial history of the Company prior to 30th June 1990. Balance sheets and profit and loss statements were prepared for each year which revealed significant losses and a deficiency in assets.

6 Mr Linke was involved in other business ventures and transactions at about this time. I mention only those which are a relevant part of the background to the matters in issue in these proceedings. He and his wife purchased a house at Stirling in about February 1989 for $925,000. With the knowledge and apparent approval of the ANZ Bank, it was financed in part by a loan of $770,000 from the State Bank of South Australia secured by a registered mortgage. Mr and Mrs Linke also owned an apartment at Glenelg which they were attempting to sell, a house property at Port Julia and land at Port Wakefield and Nuriootpa.

7 The Company incurred a loss of $186,082 for the year ending 30th June 1989 and at that date had accumulated losses of $467,412. Also, at that time there was a deficiency of assets of $427,630. As at that date the liability of the Company to the ANZ Bank had grown to $740,452, including the two overdraft liabilities which were then $198,543 and $131,909 respectively. The commercial bills remained at a total of $400,000. During the year ending 30th June 1990, the Company had sold its two service station businesses and the perfumery business. Whilst the true position is not made clear in the evidence, it appears that the last of these businesses was sold in December 1989. It had virtually no assets, those that remained were mainly stock on hand at a value in the balance sheet of $2,003. The only liabilities were the amounts due to the ANZ Bank which had been reduced upon receipt of part of the proceeds of sale of the businesses. The amounts due to the ANZ Bank at this time were $637,978 on bills and $30,373 on the overdrafts. The ANZ Bank took no steps and made no demands against the Company for the unpaid debt. That Bank was looking to Mr Linke to clear the debts in his name and those of his associated companies, including the Company by disposal of his properties.

8 For that year the Company made a loss of $299,564 and had an excess of liabilities over assets of $547,196. Accumulated losses were stated to be $766,978. The interest rate on the two bill facilities was 18.7 per cent. The annual interest cost to the Company on these bills was about $125,000. Mr Linke personally owed the Company $119,153. Unsuccessful attempts were being made to sell the properties at Stirling, Glenelg and Port Julia. The Company had massive debt and no income. It was clearly insolvent at this time.

9 It is clear that Mr Linke had other substantial business interests since acquiring the issued capital in the Company. He and his wife had various companies which owned various assets.

10 I now mention the various transactions which are particularly relevant to the matters in issue in these proceedings.

11 Mr Linke found two Mobil service stations for sale, one at Hillbank, known as Mobil Para, and the other at Salisbury Downs. He arranged for the Company to purchase them for $1,150,000 from the owners despite the financial position of the Company. The purchase price for the service station at Salisbury Downs was $680,000 and the purchase price for the other service station was $470,000. Costs incurred were about $54,000. There were some other expenses. The amount paid at settlement by the Company was $1,317,480.36. Settlement occurred on 4th July 1990. With the knowledge and approval of the ANZ Bank, the purchase was financed by a loan of $600,000 from the Bank of Singapore (Australia) Limited which offered the facility on 29th June 1990. Mr Linke proposed that the balance be financed by shareholders. The Bank of Singapore also provided another $50,000 to cover uncleared cheques issued in payment for deliveries of petrol. These loans were to be repaid by 31st January 1991. At the time of settlement a loan of $450,000, payable on 1st August 1990, was provided by the vendor. Security for the loans was a second mortgage in registrable form over the Stirling property, a debenture charge on the assets and undertakings of the Company and joint and several guarantees from Mr and Mrs Linke.

12 It was necessary to have the security of the debenture charge held by the ANZ Bank released so that the Bank of Singapore could have that security. Upon Mr Linke agreeing to ensure payment to it of $86,000, the ANZ Bank released the security and the Bank of Singapore took security in that form for the advances which it had made as well as a registered second mortgage over the property at Stirling and personal guarantees from Mr and Mrs Linke. The breakdown of the purchase price was goodwill $740,000, being $370,000 for the business of each service station, plant $80,000, hire video tapes $80,000 and stock $250,000. The land and buildings at the two sites were not part of the transaction. The Company entered into a lease with respect to each of the two service stations and franchise agreements with Mobil. On 24th July 1990 an equitable charge was given to the Bank of Singapore. The loan by the Bank of Singapore was in the form of bank bills at the interest rate of 17.1% for a period of 90 days.

13 The evidence establishes that the ANZ Bank agreed to release the security because it accepted Mr Linke's proposal to pay the interest due to the Bank from income received from the two service station businesses. The loans were to be repaid from the sale of other assets of Mr and Mrs Linke and their various other companies. At this time the ANZ Bank was the only creditor of the Company. It approved the purchase of the two service stations to enable income to be earned to pay the interest on the loan.

14 Mr and Mrs Linke contributed $96,000 to the amount due at settlement. About $10,000 of that amount was repaid to them and the balance was paid to the ANZ Bank to obtain release of the security. The Stirling property, as security for the loan to the Bank of Singapore, was inadequate. It was sold by the State Bank exercising power of sale under the mortgage for $725,000 on 14th August 1992.

15 Mr Linke knew the defendant Mr Verco through their involvement in the horse racing clubs. They had known each other for more than 20 years. Mr Linke had been Chairman of the Balaclava Racing Club for many years and Mr Verco had been Vice Chairman and then Chairman of the Strathalbyn Racing Club for about 25 years. Both were members of the committee of the South Australian Jockey Club in 1988 and 1989 during which time Mr Linke was Chairman of that Club. I accept that Mr Verco regarded Mr Linke as a fair, honest and successful businessman who had acquired substantial assets and was successful in the fuel retailing business.

16 Mr Verco is a farmer and conducted a family farming business at Lake Alexandrina since 1950. In about June 1990 Mr Linke asked Mr Verco if he wanted to participate in the fuel business. The farming business had some difficulties and Mr Linke painted a rosy picture to him of the service stations which he was buying through the Company.

17 Mr Linke said that he knew that two of the best service stations in South Australia were coming up for sale and that he was looking for people to join him in taking over the businesses. Mr Verco considered the proposal and the two men met to discuss it. Mr Linke showed documents to Mr Verco which revealed profits from one of the service station businesses of $137,000 during a year and from the other service station of $180,000 for the period of six months to the end of December 1989. Also, he showed his budgets showing expected profits of a total of $470,000 for the 1991 year. Mr Linke told Mr Verco he was looking to him to take a 12.5 per cent interest with another person taking the same interest. He said he proposed to take a 75 per cent interest himself. As the purchase price of the two service stations exceeded $1m, a 75 per cent interest would have involved a contribution by Mr Linke, or his interests, of about $750,000.

18 Mr Linke told Mr Verco that the Company could take tax losses of about $1m which, he said, would mean that profits would not be taxable until they exceeded that amount. Mr Verco told Mr Linke that he was interested in an investment that would return him between 10 and 20 per cent each year, paid half yearly, and that he did not want any active part in the management of the Company. Mr Linke told him that such a proposal was suitable to him. Mr Verco agreed to participate and caused the payment of the $200,000 which was used by the Company in the purchase of the service stations.

19 Neither Mr Linke nor Mr Verco gave evidence. Many documents were admitted into evidence from which a clear picture of various transactions can be seen. Also Mr Verco and Mr Hodge gave evidence at the trial of an action brought in this Court by Capricorn Society Ltd, a creditor of the Company against Mr Linke, Mr Verco and Mr Hodge who were the directors of the Company at the time the events, which were the subject of that action, occurred. The action did not proceed against Mr Linke as he was, by that time, bankrupt. A transcript of the evidence given at the trial by both Mr Verco and Mr Hodge was admitted into evidence. They both gave evidence which covered much of the background relevant to, and many of the issues in, the present action. That evidence is admissible and I have had regard to it. Counsel for the plaintiff, Mr Blue, contended that a consequence of the absence of Mr Verco and Mr Hodge from the witness box is that where there is a conflict in the evidence adduced by the plaintiff and the evidence of Mr Verco or Mr Hodge, the former should be preferred and further that inferences may be drawn appropriately in accordance with the principles discussed in Jones v Dunkel & Anor [1959] HCA 8; (1959) 101 CLR 298. I have kept those matters in mind but obviously admissible evidence cannot be ignored merely because Mr Verco or Mr Hodge chose not to give evidence.

20 There is another matter. The issues in the Capricorn action were not exactly the same as in the present action and arose during a much more restricted period of time, mainly from November 1991 to March 1992. The Court was concerned with an action by Capricorn Society against the directors of the Company pursuant to s592 of the Corporations Law which imposes liability upon directors of a company where the company incurs a debt which it will not be able to pay as it becomes due. This Court held Mr Verco and Mr Hodge, as the directors, to be liable having found that at relevant times the Company was insolvent and none of the defences as set out in the section were available to Mr Verco or Mr Hodge: Capricorn Society Ltd v Linke & Ors (1996) 130 FLR 19. A consequence is that neither Mr Verco nor Mr Hodge gave evidence about some matters in issue in the present case. I have also kept that matter in mind when rendering matters in issue. However, I saw no reason not to accept, for present purposes, the evidence which they gave in Capricorn and there was no matter about which any adverse inference could, or should, be drawn against either of them by reason of not having given evidence.

21 Mr Verco approached his son, Mr Tom Verco, who is an accountant and employed by Fennell, Allen & Co, a firm of chartered accountants. Mr Verco borrowed the $200,000 from the National Australia Bank on behalf of the M L Verco Family Trust. Mr Tom Verco prepared the letter written on 20th June 1990 by a principal in the firm to the National Australia Bank in support of the application for the loan. This letter confirms much of the information which Mr Linke had given to Mr Verco which has been mentioned. Mr Verco did not receive or request financial statements for the Company which, as has been mentioned, showed the poor financial position of the Company at 30th June 1989 and did not ask for them.

22 It may also be seen from the letter from Fennell, Allen & Co that it was proposed that the loan from the M L Verco Family Trust to the Company was to be repaid by instalments paid half yearly and that the shares were to be held by Mr Verco and his wife as trustees for that Trust.

23 At no time did Mr Verco, his son Mr Tom Verco or the principal of the firm of accountants ask to see copies of the financial statements of the Company nor, it seems, did the Bank. Had they done so and been provided with them, they would have seen the substantial debts owing to the banks and could have ascertained the nature and extent of the debt to the ANZ Bank.

24 Upon the payment of the $200,000, Mr Verco and his wife were allocated 1600 shares in the Company. As the total issued capital was 10,000 shares, those shares represented 16 per cent of the issued capital. Of the monies paid, $18,750 was allocated to the purchase of the shares and the balance of $181,250 was regarded as a loan to the Company. Mr Verco was appointed a director of the company on 23rd June 1990.

25 The annual financial accounts of the Company were prepared but the evidence does not disclose when they were available to the directors. They reveal that a loss of $299,564, accumulated losses of $766,978 and a deficiency in assets of $547,196. The purchase of the two service stations is not reflected in these amounts.

26 The two service stations were operated by the Company. The vendor finance had to be repaid on 1st August 1990. Mr Linke had not told Mr Verco, and he did not know, about the vendor finance. Neither Mr Linke nor any of his interests had contributed any money to the Company for the acquisition of the two service stations.

27 Mr Linke had arranged with Excel Finance Corporation Limited a loan of $200,000 which was approved on 25th June 1990. The loan was to be secured as a second charge on the assets of companies controlled by Mr Linke and guarantees from directors. On 20th July 1990, Mr Keen, acting as solicitor for Mr and Mrs Linke, requested Excel to make the loan a personal loan to Mr and Mrs Linke and stated that it would be guaranteed by the Company which would, as security, grant a second floating charge debenture.

28 The propriety of this arrangement is at best questionable. Mr Verco was by this time a director of the Company. The M L Verco Family Trust was a substantial shareholder. Mr Verco not only knew nothing about the vendor finance, but he also did not know about this proposal for securing the loan made on behalf of Mr Linke. It is questionable that in the circumstances, Mr and Mrs Linke could offer security in that form for a personal loan made to them. At all events, the loan was not made to the Company. The rate of interest was 22.5 per cent and the loan had to be repaid by 31st July 1991. The annual interest payable was $45,000 at monthly instalments of $3,750. Mr and Mrs Linke provided the $200,000 to the Company which was used as part repayment of the loan from the vendor. In that way there was the appearance of Mr and Mrs Linke having made the same contribution to the purchase price as Mr Verco.

29 On 30th July 1990 the Bank of Singapore advanced an additional amount of $100,000 at the request of Mr Linke. He represented to that Bank that a family member was to provide $200,000 but he had died. He stated that he would be able to pay $100,000 of the required loan from the vendor and requested the additional loan until the 15th September 1990. Mr Verco was not informed of this additional loan. The Bank was informed that since taking over the service station businesses, cash flow had been better than previously forecast and Mr Linke was able to provide $100,000 of the amount due to the vendors. The Bank of Singapore agreed to provide the further finance until about 15th September 1990 by which time, it was informed, another family member would provide $200,000 and acquire shares in the Company.

30 Mr Linke again approached Mr Verco and asked him to contribute a further $50,000 because, he said, he had not got the figures right and Mr Verco should have contributed $250,000, not $200,000. Also he said that additional funds were needed to provide working capital. Mr Verco agreed and caused the further contribution to be made because he thought it was a good investment. At this time, Mr Linke told him that weekly receipts of the Company amounted to $200,000.

31 When the Company commenced trading through the two service stations, the directors of the Company were Mr Linke, Mrs Linke, Mr Verco and Mr Keen, who I understand was also the solicitor for the Company. At all times Mr Linke acted as the managing director and chief executive officer of the Company with a small administrative staff. He managed the businesses and the Company.

32 The time for repayment of the additional loan was extended to 31st January 1991 provided repayment of principal was made by instalments of $25,000 each month commencing on 15th October 1990. This additional loan was increased by a further sum of $75,000 in November 1990 which also had to be repaid by 31st January 1991.

33 Mr Verco saw Mr Linke about once each week at committee and other meetings of the South Australian Jockey Club. On these occasions Mr Linke spoke positively about the Company. In July 1990 he said to Mr Verco that the Company was trading very, very well, "It is looking as though we are in a very good thing". In August 1990, he told Mr Verco that the Company was trading very well. He made similar statements every month and told Mr Verco that he was banking between $100,000 and $120,000 each week. As has been mentioned, when Mr Linke asked Mr Verco to contribute another $50,000, he told him that the amount of the weekly receipts was $200,000. He gave another favourable report in September 1990 and mentioned the need for expansion. In October 1990 Mr Linke said that sales of food, cigarettes and soft drinks had increased markedly.

34 During this month financial accounts for the three months ending on 30th September 1990 were provided to Mr Verco. These accounts showed a net profit of $32,998 for Mobil Salisbury Downs and $58,508 for Mobil Para. It was at about this time, the debt due to the Bank of Singapore was rolled over until 31st January 1991 and a further $75,000 was borrowed, making the total bill facility $175,000. The purpose of the additional loan was to provide further working capital pending "the injection of $200,000 shareholder funds" according to the letter from the Bank of Singapore to the Company dated 2nd November 1990.

35 In November 1990, Mr Linke again mentioned expansion to Mr Verco. He also said that with summer approaching, the businesses were getting better and better all the time. Trading statements for the period ending 31st October 1990 were prepared and given to Mr Verco. They revealed a net profit of $51,752 for Para and $53,262 for Salisbury Downs. The evidence does not disclose that trading statements were not prepared for the month of November 1990. In December 1990 he told Mr Verco that gross takings for a weekend reached $150,000.

36 I now turn to the financial position of the Company as at 31st December 1990. The debt due to the ANZ Bank had grown to $730,841.81 using a simple interest calculation as no interest had been paid since 30th June 1990. A calculation of compound interest would result in a much higher debt. On 26th December 1990 that Bank wrote to Mr and Mrs Linke requiring them to pay interest of a total amount of $250,000 by instalments ending on 8th April 1991 and to make payments in reduction of the principal of $200,000 on 4th January 1991, $100,000 on 28th February 1991 and $650,000 on 8th April 1991. None of those payments were ever made. In addition, the debt of the Company to the Bank of Singapore was $600,000, making a total debt in excess of $1,330,000. The debt of Mr and Mrs Linke to Excel remained at $200,000. All payments of interest to the Bank of Singapore had been made. Appropriate calculations establish that the annual interest liability to the two banks could have been in the order of $215,000 if an average interest rate of 17 per cent is applied. In addition, the Company was obliged to pay the total due to the Bank of Singapore by 31st January 1991 and the reductions in principal to the ANZ Bank which have been mentioned. Trading and profit and loss statements prepared for the half year ending 31st December 1990 showed a total net profit for both service stations of $139,989 after a provision for bank interest of $50,162. A balance sheet was prepared which showed assets of $1,365,824 made up of plant and videos ($210,663), current assets including stock ($365,762) and intangibles ($789,399), including goodwill of $775,898. The balance sheet also showed liabilities of $1,773,030, including loans of $786,195, a bank loan of $92,963 and a loan from the Bank of Singapore of $725,000. An excess of liabilities over assets of $407,206 was disclosed in the balance sheet. An increase in goodwill of $35,898 over the amount paid in early July 1990 was shown in the balance sheet.

37 The accounts reflect the purchase and operation of the service station businesses and it will be seen that they show a profit compared with the loss shown in the June 1990 accounts and a reduction in the deficiency in assets.

38 Mr Verco was given a copy of these accounts. When giving evidence in Capricorn, he said that the net profit represented a net profit of about $280,000 for a full year which, although not as good as the September quarter, was regarded by him as a "happy, healthy looking profit". These figures did not represent the true position of the Company at that time, as there was no amounts included for amortisation of goodwill or depreciation. Also, the net profit was substantially less than the profits predicted by Mr Linke for the 12 months to 31st March 1991.

39 It is fair to say that if the profit and loss statements included correct amounts for depreciation, particularly for videos used in the video hire part of the business, plant and equipment, and motor vehicles, and if goodwill was amortised over the period of the lease of the service station and the Mobil franchise, the profit of the Company may have been insufficient to meet the total interest cost for the year which, as has been seen, was about $215,000, and would not have been sufficient to enable the Company to reduce the principal sum of the loans. Mr Verco told the Court in Capricorn that he did not recall noticing the excess of liabilities over assets when he saw the accounts and said that had he done so, it would have caused him concern.

40 In January 1991 Mr Linke told Mr Verco that the businesses were going well and that he could expect a dividend as there had been trading for six months. In fact, there had been trading for only five months. Repayment of the loans from the Bank of Singapore became due on 31st January 1991. Mr Linke had not sold the properties at Stirling or Glenelg. The Company could not repay the debt and the Bank of Singapore extended the time for payment until 31st May 1991 and subsequently to the 30th June 1991. The Bank of Singapore required payment of the principal sum by instalments of $20,000 on the last day of each month commencing on 28th February 1991, together with interests payable at the same time with the balance of the principal now being paid on 30th June 1991.

41 In February 1991, the M L Verco Family Trust received a cheque for $20,000. Mr Linke told Mr Verco that this amount was his share for the first eight months of trading. This payment, said by Mr Linke to be a dividend, was debited to the loan account of the M L Verco Family Trust in the Company without Mr Verco's knowledge. Mr Verco expected another dividend of $30,000 at about the end of the financial year. His evidence in Capricorn was that he did not receive a further dividend or payment which caused concern but he thought the reason was the expansion of the business of the Company.

42 No trading or profit and loss accounts were prepared for the period ending March 1991. According to Mr Verco, Mr Linke told him that he hoped to have accounts prepared by the end of June 1991. He said there was delay because the computer was causing problems, as it had recently been acquired and was appeared not to have been programmed properly. Mr Verco was told by Mr Linke that the Company had performed very well in March 1991. It was at this time that Mr Linke informed Mr Verco that he hoped that Mr Hodge would soon invest in the Company. As will be seen, he was known to the two men through horse racing circles.

43 Records of the Australian Taxation Office admitted into evidence reveal that the Company was late in making payments of PAYE tax in February, March and April 1991 and also was late in making such payments in the first half of the next financial year. However, the payments were made.

44 At this time Mr Linke had not sold the Stirling, Glenelg or Port Julia properties and payments of principal and interest as required by the ANZ Bank had not been paid. That Bank wrote to Mr Linke on 21st March 1991 informing him that his promises to reduce the debt and pay interest had not been kept. He was informed that if there had not been a satisfactory resolution of the matters by 1st April 1991, that Bank would demand full repayment of the loans and act upon the security. The interest payments due on 1st February 1991, 1st March 1991 and 1st April 1991 were not paid by Mr and Mrs Linke or the Company. In April 1991 Mr and Mrs Linke were considering the sale of all of their assets except the shares in the Company and on 21st April 1991 Mr Veitch wrote to the ANZ Bank with proposals for such sale and substantial reduction of the debt to the Bank.

45 Mr Linke approached Mr Hodge in about February or March 1991 to invest in the Company. He was a mutual friend of Mr Linke and Mr Verco of many years standing and was also involved in the racing industry. He had been the Deputy Chairman of the Murray Bridge Racing Club and was also a member of the committee of the South Australian Jockey Club. At the time of giving evidence, he was Chairman of that Club. He and his wife were farmers on their own property at Coonalpyn. Mr Linke told him of the involvement of Mr Verco in the Company whom Mr Hodge was also seeing frequently. Mr Verco told him that he had received a dividend of $20,000. Mr Linke spoke to Mr Hodge very favourably about the Company and the service station businesses and told him that he could expect to earn 20 per cent per annum on any investment. Mr Hodge told him that he wanted a dividend each six months because he would be borrowing money if he did invest in the Company. Like Mr Verco, he told Mr Linke that he knew nothing about the running of service stations and said he would expect to be a "sleeping partner" with Mr Linke as the chief executive. Mr Hodge agreed that he and his wife would contribute $125,000 which they paid. Mr and Mrs Hodge acquired 800 shares in the Company or eight per cent of the issued capital of the Company for $50,000 and the balance of $75,000 was regarded as a loan by them to the Company.

46 Mr Linke gave Mr Hodge the financial statements for the period ending 30th December 1990 and the budget for the year ending 30th June 1991. As has been seen, these budgets showed a net profit, before income tax, of $252,085 for Mobil Salisbury Downs and $218,020 for Mobil Para, but as has been seen did not include any deductions for interest or amortisation of goodwill and only an insignificant amount for depreciation. Mr Hodge did not ask to see, and did not receive, the financial statements of the Company for the year ending 30th June 1990. Mr Linke informed Mr Hodge that the Company had incurred income tax losses of a million dollars. Mr Linke did not tell Mr Hodge about the debt due to the ANZ Bank.

47 In April 1991 Mr Linke approached Mr Siegle, a relative, who also agreed to acquire eight per cent of the issued capital of the Company. Documents admitted into evidence establish that Mr Linke asserted to Mr Siegle that the Company was solvent at this time but had accumulated losses of $626,988 which would be used before dividends could be paid. These documents reveal that Mr Linke represented the Company to Mr Siegle in a most favourable light. He proposed that he and Mrs Linke would own 6,800 shares, Mr Verco (in fact the M L Verco Family Trust) would own 1,600 shares, Mr Siegle would own 800 shares and Mr Hodge would also own 800 shares. In consequence, Mr and Mrs Linke would own 68 per cent of the issued capital. Mr Siegle agreed to participate and paid $125,000 which was apportioned as $50,000 for the shares and $75,000 by way of a loan.

48 The shares were issued to Mr and Mrs Hodge and Mr Siegle on 15th May 1991 and they became directors on 28th May 1991.

49 At about this time, Mr Linke told Mr Verco that the Company has acquired a new and bigger computer system for the service stations and then told him that he was having difficulties with it which, according to Mr Linke, continued throughout 1991. No monthly or other financial statements were produced.

50 The Company was experiencing cash flow problems. The interest payments due on the loan from Excel were not paid during the period of four months from February 1991 to May 1991, although that obligation was not the responsibility of the Company. The Bank of Singapore made requests for payment of interest due. These payments were made, but not on time.

51 By April 1991, Mr Linke was experiencing a financial crisis. Mention has been made of the letter he received from the ANZ Bank and the letter which he caused his accountant, Mr Veitch, to write to the Bank on 17th April 1991 making a proposal for the intended sale of the various assets in which he had an interest, except the Company. In this letter reference is made to the so-called tax losses in the Company and the proposed investment of $500,000 by three associates, presumably Mr Verco who had already made his contribution, Mr Hodge and Mr Siegle. Mr Veitch wrote that of this sum $250,000 would be paid to the ANZ Bank and the balance would be used for working capital and to reduce the debt to the Bank of Singapore.

52 Mr Hodge had consulted his accountant, Mr Storer who wrote a letter to him on 6th May 1991 setting out matters which had been discussed between them. This letter is significant because it reveals aspects of the state of the knowledge of Mr Hodge about the Company at that time. These matters were that at the 31st December 1990 there was a shortfall in shareholders' funds of $407,206 which resulted from trading or other losses of $626,998 offset by capital profits of about $220,000 and that the Company's operations were being funded by Directors' loans of $826,195 and a current advance from the Bank of Singapore of $725,000. The major asset of goodwill of $775,898 was purchased on 2nd July 1990. Mr Storer made recommendations to Mr Hodge about the need to: establish the terms and conditions of the Directors' loans; which would be more accurately described as shareholders' loans; closely examine the terms and conditions of the advance from the Bank of Singapore; and, analyse and reach an understanding of the value of goodwill. He also recommended that, if possible, industry guidelines should be examined to ascertain the existence and actual value of the goodwill. It will be seen that there is no mention in this letter of the debts due to the ANZ Bank and to Excel which are not mentioned as such in the balance sheet for the period ending 31st December 1990. However, it appears that a large part of the $826,195 for Directors' loans was the debt due to the ANZ Bank.

53 Mr Hodge told the Court in Capricorn that he spoke to Mr Linke about the recommendations made by Mr Storer. He said he could not remember what Mr Linke told him but he passed the response of Mr Linke on to Mr Storer who appeared satisfied with it. Mr Linke told Mr Hodge that he could expect a return of 20 percent on his investment. In cross-examination in Capricorn, Mr Hodge said that Mr Linke had not given him particulars of the loan from the Bank of Singapore, including the interest rate charged, the repayment terms and that it had initially been for a period of six months and had subsequently been extended. His evidence establishes that his enquiries of Mr Linke about these matters were inadequate.

54 Mr and Mrs Linke were equal shareholders in Batmass Pty Ltd ("Batmass"). It was proposed by Mr Linke to restructure the shareholding in that Company to involve Mr Verco, Mr Hodge and Mr Siegle to the same extent. Batmass has only limited significance for present purposes. When each of these men caused the respective contributions to be made to the Company, some part of each contribution was applied to Batmass which acquired another service station.

55 Financial statements for the Company were prepared for the period ending 30th April 1991. These accounts show a net profit of $128,776 and an excess of liabilities over assets of $409,111. Current liabilities are shown as $1,282,778, including loans from directors of $677,427 and non current liabilities of $727,000, including the loan from the Bank of Singapore. There is no reference to the loans from the ANZ Bank and Excel.

56 By the end of May 1991, the ANZ Bank was considering what action to take against Mr and Mrs Linke to recover the amount due on the loan. On 20th June 1991 a manager of that Bank wrote to Mr and Mrs Linke informing them that the Glenelg and Port Julia properties, and another property at Nuriootpa, had to be sold as a priority and if contracts for sale and purchase were not sent to the Bank by 15th July 1991, the Bank would take possession of them. Also, they were informed that the Bank would not write off any part of the debt. The ANZ Bank expected repayments to include the proceeds of the sale of shares in the Company and the property at Stirling and from profits earned.

57 In my view, this letter is of significance. The ANZ Bank did not write to the Company. It made no demands of the Company, only of Mr and Mrs Linke. The Bank did not say anything about the sale of assets of the Company. There was mention of a proposal, apparently made by Mr and Mrs Linke to reduce their loan by sale of "equity" in the Company, which is, presumably, a reference to their shares. Despite the default in payment of the loan, which the Bank clearly regarded as a default of Mr and Ms Linke, the Bank was willing to allow the Company to continue to operate the two service station businesses. There was no threat of any action against the Company.

58 On about 27th June 1991 and about 10th July 1991, cheques written by the Company on an operating account with the State Bank of South Australia were dishonoured but subsequently paid.

60 The loans due to the Bank of Singapore had not been paid by the due date on 30th June 1991. Mr and Mrs Linke had not sold any of the assets in which they, or their companies, had an interest. There were no funds available to pay that loan and that Bank extended the time for payment until 12th July 1991 and soon thereafter an extension was made to 31st July 1991. The amount due on the principal loan had increased from $600,000 to $645,000. However, all interest payments due to the Bank of Singapore had been made during that financial year. That Bank had allowed the Company to continue to operate the two service station businesses and, as has been seen, increased and extended loans for that purpose.

61 Mr Linke arranged for the loan from Excel which was due to be repaid on 1st August 1991 to be extended to 1st August 1992. The principal sum due at this time was $190,000. It appears that although the loan was made by Excel to Mr and Mrs Linke, interest payments and the reduction in principal had been made by the Company.

62 The financial statements and taxation returns for the year ending 30th June 1991 for the Company were prepared in August 1991. They reveal an operating, or net, profit of $35,491. The balance sheet showed a deficiency in assets of $464,710 and an accumulated loss of $731,486. Total assets were shown as $1,428,336 made up of fixed assets of $248,754 (being plant and equipment, motor vehicles and stock) and intangible assets of $786,745, the main item being goodwill shown at $774,898. The liabilities were $1,893,710, made up of current liabilities of $318,857 being bank overdrafts, trade creditors and an advance from a finance company and non-current liabilities of $1,574,189, being made up of the loan from the Bank of Singapore of $645,000, another small loan and unsecured loans of $887,189.

63 It will be remembered that not all of the contributions by Mr Verco, Mr Hodge and Mr Siegle were applied to the Company. Some amounts were applied to Batmass. The unsecured loans were alleged to be made up as M L Verco Family Trust $129,150, Mr and Mrs Hodge $93,219, Mr and Mrs Siegle $74,575 and Mr and Mrs Linke $590,245.

64 This breakdown was prepared by Mr Linke's accountant after making some allocation for the acquisition of shares for each of them in both the Company and Batmass. The shareholding of each of them was the same as in the Company. The amounts allocated to their respective loan accounts is not relevant for present purposes, except that it is significant that as with the loan accounts in the Company, Mr Linke attributed the vast majority of the shareholders' loans to himself and his wife, even though they had not made any direct contribution.

65 With respect to the Company, he attributed the loans from the ANZ Bank and Excel as capital introduced by him, most of which he treated as loans by him and Mrs Linke. Also he had been drawing monies from the Company and the balancing of the loans and drawings resulted in the amount of $590,245. The moneys which he withdrew were applied to the acquisition of a Caltex service station by Batmass and a service station at Wallaroo. The ANZ Bank and Excel were not treated in the accounts of the Company as creditors so far as I can ascertain. The amounts due to them were treated as shareholders' loans introduced by Mr and Mrs Linke. This treatment of the loan from the ANZ Bank disguised the true position from the other directors.

66 Mr Verco, Mr Hodge and Mr Siegle received these financial accounts and annual report signed by Mr Linke, purportedly on behalf of all of the directors. This report is generally expressed in favourable terms although acknowledging trading for the year had been disappointing in terms of net profit and was well down on budget, but, it was stated, "the immediate and long term looks bright". Mr Linke reported that he had clearly identified most of the major problem areas. It will be remembered that the budget for net profit was about $400,000. Mr Linke also acknowledged that the monthly reports left much to be desired and stated that he proposed to be a full time working director which would assist in establishing a much greater degree of management information. Nevertheless he made positive statements about the future and showed optimism. He stated that he would in future be reporting on a monthly basis Mr Linke prepared a budget for the year ending 30th June 1992 indicating a net profit of $105,600 for Para and $103,800 for Salisbury Downs with considerable detail to support those amounts. In the annual report he stated that he believed that the budget would be achieved.

67 Mr Verco said that he received these financial statements, the annual report and the budget in September 1991. He said he was unhappy with these documents and he took them to his son who prepared a letter from him to send to Mr Linke. That letter was sent on 21st October 1991. I mention only a few matters set out in the letter. Mr Verco sought details of the unsecured loans, individual trading and profit and loss statements for the Para and Salisbury Downs service stations and copies of the income tax returns for the Company and for Batmass. Part of the letter was:

"6. As I am a Director of S.A. Service Stations Pty. Ltd., it is of concern that the Accounts supplied to me are not in accordance with Schedule 5 of the Corporations Law. If there were only a set of Management Accounts, please could you supply me with the final complete set, including Notes to and Forming Part of the Accounts and a Sources and Application of Funds Statement."

Mr Verco did not receive a reply to that letter but he continued to see Mr Linke who told him that everything was going well. He continued to blame the computer for having to give verbal reports.

68 On 6th August 1991 Mr and Mrs Linke and the Company, and Batmass through Mr Linke, and Excel, executed a Deed varying the terms of repayment of the loan from Excel. The principal sum at that time was $190,000. The terms of repayment were by quarterly instalments of $25,000 at the end of each of September 1991, December 1991, March 1992 and June 1992, with a final payment of $90,000 on 1st August 1992. The Deed provided for an interest rate of 18 per cent and that the Company and Batmass would guarantee the loan. Mr Linke did not inform the other directors of those matters.

69 Mr Hodge said that Mr Linke handed him the financial accounts and the report. All Mr Linke said was that trading in the winter months of April, May and June was very poor and that he had not budgeted for two or three reasonably substantial accounts.

70 In August 1991 he told Mr Verco that there had been "good trading" and that he was keen on some expansion.

71 In October 1991 he had a further discussion with Mr Linke and was told that it was spring and trading was improving. He was told much the same by Mr Linke in November who was enthusiastic and confident.

72 On 3rd December 1991, the shareholders executed an agreement which, inter alia, reflected the shareholding in the Company and their loan accounts as has been mentioned on the basis of $8,071.87 for each one per cent of the share capital of the Company held by him, or them. Interest was to be paid at a specified rate on the first day of each of July, October, January and April each year.

73 On this day there was a meeting of directors attended by the four directors, Mr Linke, Mr Verco, Mr Hodge and Mr Siegle and, by invitation, Mr Keen, Mr Veitch and Mr Greatbatch who worked in an administrative capacity in the service station business. The manager mentioned breakdown of the computer and that financial "figures" could not be presented. Mr Linke produced a handwritten document of trading results which was the first report for that financial year. Those results were regarded as favourable. The directors agreed that monthly reports would be provided, including actual results and budget figures for the month and the year to date with the amounts of any variations. The minutes record that Mr Verco "reinforced his views" as expressed in his letter to Mr Linke and Mr Hodge and Mr Siegle required the payment of interest on the loans. Mr Linke said that he was considering installing a car wash at the service station at Para at an expense of $115,000.

74 Other financial accounts for the year ending 30th June 1991 were prepared incorporating the same results but in the format required by Schedule 5 of the Corporations Law. They were required by Mr Linke and Mr Hodge on 17th December 1991. They were forwarded to Mr Verco's son on 24th January 1992.

75 On 23rd December 1991, Excel made a demand upon the Company for payment of $197,774.53 being the balance due under that loan within 21 days failing which proceedings might be taken to wind up the Company pursuant to s460(1) of the Corporations Law. Presumably this demand was made pursuant to the guarantee. In my view, there is doubt about the validity of the guarantee. The common seal of the Company was fixed without resolution of the directors. There is no evidence to suggest that Mr Linke was authorised by the Company to give the guarantee or to affix the common seal. However, that is not a matter which received prominence at the trial. Also, there is no evidence that Excel had called upon Mr and Mrs Linke to pay the loan before purporting to call upon the Company as a guarantor. Mr Linke did not inform the other directors of this decision.

76 During the period to 31st December 1991, the Company made payments of interest to the Bank of Singapore as required, although the payment for December was paid late.

77 On 21st January 1992 a manager at the ANZ Bank wrote to Mr and Mrs Linke setting out the balances of various accounts. The total amount due by Mr and Mrs Linke and entities controlled by them as at 20th January 1992 was $812,724.87. The total amount due by the Company was $859,697.63, making a total debt of $1,672,422.50. As has been mentioned, the debt of the Company to the ANZ Bank as at 30th June 1990 was $660,000. I have assumed that the reason for the increase was unpaid interest.

78 During the period from 1st July 1991 until 31st December 1991, the Company incurred interest on the loan from the Bank of Singapore of $43,261.68 and further interest of $6,308.65 in January 1992 and $5,951.13 in February 1992. As at 21st February 1992, unpaid interest and instalments of principal amounted to $12,500.

79 In January 1992 Mr Linke again told Mr Verco that the Company was trading well and said that there would be another dividend paid soon which would hopefully be larger than the previous dividend. In January and February 1992, Mr Linke told Mr Hodge that the summer trading was going well.

80 In early 1992 Mr Linke arranged an informal meeting of his creditors in order to put to them a scheme of arrangement. On 25th February 1992 the Bank of Singapore appointed Mr Irving of Arthur Andersen and Co to assist it by assessing the likely impact of the proposed scheme upon that Bank.

81 He undertook a review of the business of the Company and made a report to the Bank of Singapore. On 9th March 1992 he recommended to that Bank that it not agree to proposals put forward by Mr Linke which are irrelevant for present purposes and that it take control of the Company and appoint Receivers and Managers.

82 On 9th March 1992 the Bank of Singapore informed the Company that $68,451.13 was owing, being $62,500 as arrears of payments of principal and $5,951.13 being arrears of interest and demanded that these arrears be paid by 3.00 pm on 11th March 1992. Payment was not made and on 12th March 1992 the Bank of Singapore, pursuant to the equitable charge which it held, appointed Mr Irving and Mr Young, also of Arthur Andersen as managers and receivers of the Company by Deed made on 12th March 1992. They took charge of the affairs of the Company immediately. It may be seen that the arrears of interest under the loan from the Bank of Singapore at this time were only a little less than $6,000.

83 At 12th March 1992 the Company owed $152,476.94 to Mobil, which the managers and receivers paid on 17th March 1992. This amount was due to for fuel purchase by the Company in March 1992. Invoices from Mobil were admitted into evidence which show that as at 29th February 1992, the total amount overdue to Mobil was only $15,133.27.

84 Shortly after the managers and receivers were appointed, Mr Linke informed Mr Verco of what had happened. Soon thereafter Mr Verco, Mr and Mrs Hodge and Mr Linke met at the property at Glenelg. Mr Linke informed them that they would have to find $300,000 if they wished to sell the Company but Mr Verco and Mr Hodge could not make a further contribution. It was only after the managers and receivers were appointed that Mr Verco and Mr Hodge became aware that some creditors had not been paid, that the Company had purported to guarantee the loan from Excel, and that the Company was indebted to the ANZ Bank.

85 At about this time, Mr Linke's accountant wrote to him explaining how the shareholding of each of the contributors to the Company had been determined. By this time, Batmass had purchased the Caltex Service Station at Ingle Farm which was operated through a unit trust with shares being issued in the trustee company, Batmass, in the same proportions as the shareholding in the Company, but it was reported that the shareholding of Mr and Mrs Linke was 66 per cent, which is a reduction of two per cent from what is disclosed in earlier documents, and the shareholding of Mr Siegle was 10 per cent which is an increase of 2 per cent. These differences are of no significance except that it appears that neither Mr Verco nor Mr Hodge participated in the decisions resulting in these alterations.

86 The receivers and managers continued to operate the service stations at Para and Salisbury Downs until 22nd and 23rd June 1992 respectively when they were sold. The spare parts division of the business at Salisbury Downs was sold on 25th June to another purchaser. Mobil exercised its rights under franchise agreements with the Company and acquired both service station businesses at the same prices as had been offered by intending purchasers.

87 The receivers and managers published a summary of receipts and payments from the date of their appointment for a period of six months. The two service station businesses were sold for $752,526, being $414,673 for Para, $199,447 for Salisbury Downs and $138,406 for the spare parts division. A further $8,000 was received from the purchase of the spare parts division for goodwill and $2,424 for the sale of surplus shelving. During their period of administration, Mr Irving and Mr Young carried on the business of the two service stations and made a net profit of $52,851. The Bank of Singapore recovered most of the amount due to it. The ANZ Bank recovered part of the amount due to it from the sale of assets in which Mr Linke had an interest or controlled which amounted to $620,000 and the remainder of that debt was claimed against the Company but was written off by the ANZ Bank. Excel recovered the proceeds of the two motor vehicles but otherwise that loan was not repaid. The shareholders did not recover any of their loans, although both Mr Verco's interests and Mr Hodge's interests had sold them to obtain income tax deductions. The Reports of Affairs of each of Mr Verco and Mr Hodge are in much the same terms and reveal that the total amount due to creditors was $1,654,070, excluding any debt to Excel.

88 The Company was wound up by order of this Court on 8th July 1992. Mr Siegle died in 1993. Mr and Mrs Linke were declared bankrupt on 13th October 1993 and 7th February 1994 respectively. These proceedings were commenced on 24th June 1996.

89 I shall return to aspects of this factual background in due course. At this stage, it is sufficient to note that after Mr Verco and Mr Hodge became directors of the Company, there were no directors' meetings except for the meeting on 3rd December 1991. The financial position of the Company at 30th June 1990, and thereafter until the appointment of the receivers and managers, was reported in favourable terms by Mr Linke to Mr Verco and Mr Hodge on a regular basis and also in various financial accounts and budgets.

90 Mr Linke did not give evidence. Although he was a party to the action, it was discontinued against him on 10th February 1998. He has not been called upon to answer allegations made about him and consequently adverse findings about him in these proceedings should only be made when necessary and upon only the clearest evidence. With those observations in mind, it has been clearly established that Mr Linke misled Mr Verco, Mr Hodge and Mr Siegle in many important aspects. Also, he misled the ANZ Bank, the Bank of Singapore and Excel. He misled all of them as to the financial position of the Company and the two service stations. At all times he represented the Company and the business as profitable, in a sound financial position and with considerable potential. In fact, as has been seen, the Company had a substantial liability to the ANZ Bank before the two service stations were purchased. Substantial liabilities of interest payments, depreciation and amortisation of goodwill were never brought to account in the various budgets and profit and loss statements or, if so, in a totally inadequate manner. Having regard to all outgoings and liabilities, the Company did not make a profit having regard to those items during any relevant period which was kept from the other directors by Mr Linke.

91 It is the plaintiff's case that both Mr Verco and Mr Hodge were in breach of their duties as directors of the Company in many respects which caused the losses to the Company after their respective appointments.

92 It is alleged against both of them that throughout the whole of these respective directorships, they completely abrogated all, and carried out none, of their responsibilities and were in breach of their duties to the Company under s 232(4) of the Corporations Law and at common law.

93 At the relevant times the Corporations Law provided that a director is an officer of a corporation: s 232(1). Section 232(4) provided:

"232(4) An officer of a corporation shall at all times exercise a reasonable degree of care and diligence in the exercise of his or her powers and the discharge of his or her duties."

94 Prior to 23rd June 1993, there were no provisions in the Corporations Law which made directors liable to a company for insolvent trading, that is incurring debts when the company was unable to pay its debts, as and when they fall due. There was liability to creditors in those circumstances pursuant to s592 of the Corporations Law. Capricorn is an example of directors being held liable pursuant to that provision. Such liability to a company was imposed by s588G of the Corporations Law which came into operation on 23rd June 1993 without any retrospective application. So, the plaintiff's claim is not that Mr Verco and Mr Hodge, as directors, are liable for debts incurred in trading when the Company was insolvent but that they had a duty to the Company pursuant to s232(4) and at common law to cause the Company to cease trading when it was insolvent and trading at a loss. Whilst it is alleged that Mr Verco and Mr Hodge were in breach of their respective duties as from the respective times when they became directors, the claim for damages is limited to the losses incurred as from 1st July 1991 until the managers and receivers were appointed.

95 It is the defendants' case that the claim is misconceived. Directors are not in breach of duty in allowing a company to trade at a loss. Many public and private corporations do so commonly. Many companies trade at loss for particular periods of time in anticipation of returning to profitability in the near future. On the defendant's case, liability does not attach to directors under s232(4) or at common law in those circumstances. The researches of counsel did not reveal any case where directors have been found liable to the company in such circumstances or in the circumstances of the present case. Furthermore, it is the defendant's case that they could not have ceased the trading of the businesses of the Company even if aware of the financial position of the Company during the relevant period because to have done so would have caused the Company to lose its assets, namely the two service station businesses. The defendants point to what in fact happened when the Bank of Singapore appointed the managers and receivers of the Company. They continued to trade the two businesses and did so profitably.

96 I accept that directors of a company owe a duty of care to the company at common law: Permanent Building Society (In Liq) v Wheeler & Others (1994) 14 ACSR 109, Daniels & Ors v Anderson & Ors (1995) 37 NSWLR 438 at p488 and following; see also Rogers CJ at first instance (1992) 10 ACLC 993 at p1012ff. I accepted that there was such a duty in Duke Group Ltd (In Liq) v Pilmer & Ors [1998] SASC 6529; (1998) 144 FLR 1 at p37. The Full Court of this Court in the appeal in Duke Group was prepared to accept, for the purpose of that appeal, that a director owes a duty of care at common law to the company: Duke Group Ltd (In Liq) v Pilmer & Ors (No 2) ([2000] SASC 418 at p2; see also Gower's Principles of Modern Company Law 6th Ed pp598-599 and pp648-649.

97 Before considering the nature and extent of the duty imposed upon a director of a company by s232(4) and the common law, it may be observed that it is in essence the same. In Daniels v Anderson Powell JA made that observation at p602. In considering the nature and scope of that duty, it is appropriate to have regard to specific duties of directors pursuant to the Corporations Law which existed throughout all of the time when Mr Verco and Mr Hodge were directors. They included the duty to ensure that the Company kept a minute book (s258) and that the Company kept accounting records which correctly recorded and explained its transactions and financial position and which allowed for the preparation of true and fair accounts capable of audit (s289). There is the duty of directors after the conclusion of a financial year to make out a profit and loss account and balance sheet which gave a true and fair view of the company's state of affairs at the end of the relevant accounting periods (ss292 and 293). In doing so they must first take reasonable steps to ascertain what had been done about writing off bad debts and making provision for doubtful debts, and cause all known bad debts to be written off and adequate provision to be made for doubtful debts (s294(2)) and whether any current assets are unlikely to realise, in the ordinary course of business, their value as shown in the company's accounting records and, if so, to cause the value of those assets to be written down or cause adequate provision to be made (s294(3)) and whether the value of any non-current asset is shown in the company's accounting records at an amount that, having regard to the asset's value to the company as a going concern, exceeded the amount that it would have been reasonable for the company to spend to acquire the asset as at the end of the financial year and, if so, make adequate provision or include any necessary information or explanations in the accounts (s294(4)).

98 Directors are obliged, for each accounting period, to state whether the Company's profit and loss account gave a true and fair view of the Company's profit and loss for the accounting period (s301(2)(a)), the balance sheet gave a true and fair view of the company's state of affairs as at the end of the accounting period (s301(2)(b)) and, in their view, there were reasonable grounds to believe that the company would be able to pay its debts as and when they fell due (s301(5)).

99 Directors are obliged to ensure that the Company's financial statements for the relevant accounting periods complied with the prescribed requirements relevant to the financial statements (s297(1)), and that the Company complied with relevant accounting standards (s298) and that an annual general meeting of the Company is held at least once in every calendar year and within a certain time after the end of the relevant financial year (by 31 December) and to lay the company's financial statements before the annual general meeting of the company.

100 They are basic duties with relevance to the present case and are within the nature and scope of the duty at common law. In considering that matter, considerable assistance is to be found in the observations of Clarke JA and Sheller JA in Daniels v Anderson at pp500-501:

"The insolvent trading cases demonstrate that ignorance is no longer necessarily a defence to proceedings brought against a director. In some respects, at least, the director must inform himself or herself about the affairs of the company.

There is no doubt reason for establishing a board which enjoys the varied wisdom of persons drawn from different commercial backgrounds. Even so a director, whatever his or her background, has a duty greater than that of simply representing a particular field of experience. That duty involves becoming familiar with the business of the company and how it is run and ensuring that the board has available means to audit the management of the company so that it can satisfy itself that the company is being properly run. The board may be assisted by sub-committees consisting of its members, including non-executive directors: see generally, Sievers, Farewell to the Sleeping Director, (1993) 21 Australian Business Law Review 111 at pp115-117.

In our opinion the responsibilities of directors require that they take reasonable steps to place themselves in a position to guide and monitor the management of the company. The board of AWA met only once a month for half a day. But to our mind the board should meet as often as it deems necessary to carry out its functions properly. The question is what in the particular case are the duties and responsibilities of the directors and then what time is required of them as a board to carry out these duties and responsibilities. It is not a matter of tailoring the extent of the duty or function to pre-fixed intervals between board meetings."

101 As has been seen, in the present case Mr Verco and Mr Hodge may aptly be described as non-executive directors and Mr Linke as the executive director and manager of the Company. The evidence discloses that Mr Verco and Mr Hodge trusted and relied upon Mr Linke and, it must be said, that he deceived them. That matter was discussed in Daniels v Anderson by Clarke JA and Sheller JA at p502:

"A matter of particular significance in these appeals is the extent to which directors are justified in trusting and relying upon officers of the company. Rogers J said that a director is justified in trusting such officers to perform all duties that, having regard to the exigencies of business, the intelligent devolution of labour and the articles of association, may properly be left to them. He said that a director is entitled to rely without verification on the judgment, information and advice of the officers so entrusted and on management to go through relevant financial and other information of the corporation and draw to the board's attention any matter requiring their consideration. The business of a corporation could not go on if directors could not trust those who are put into a position of trust for the express purpose of attending to details of management. Reliance would only be unreasonable where the director was aware of circumstances of such a character, so plain, so manifest and so simple of appreciation that no person, with any degree of prudence, acting on his behalf, would have relied on the particular judgment, information and advice of the officers. A non-executive director does not have to turn him or herself into an auditor, managing director, chairman or other officer to find out whether management is deceiving him or her. These are the words uttered in 1872 by Lord Hatherly LC in Overend & Gurney Co v Gibb (1872) LR 5 HL 480 at 487 in describing crassa negligentia. In our respectful opinion it does not accurately state the extent of the duty of directors whether non-executive or not in modern company law."

Their Honours went on to refer, with approval, to the observations of Pollock J in giving the opinion of the Supreme Court of New Jersey in Francis v United Jersey Bank 432 A 2d 814 (NJ 1981) at pp821-823:

"As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged: Campbell v Watson 62 NJ Eq at 416, 50 A 120. Because directors are bound to exercise ordinary care, they cannot set up as a defence lack of the knowledge needed to exercise the requisite degree of care. If one 'feels that he has not had sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act.' Campbell v Watson (at 416, 50 A 120).

Directors are under a continuing obligation to keep informed about the activities of the corporation. Otherwise, they may not be able to participate in the overall management of corporate affairs: Barnes v Andrews 298 F 614 (SDNY 1924) (director guilty of misprison of office for not keeping himself informed about the details of corporate business); Atherton v Anderson 99 F 2d 883, 889-890 (6 Cir 1938) (ignorance no defense to director liability because of director's 'duty to know the facts'); Campbell at 409, 50 A 120 (directors 'bound to acquaint themselves with ... extent ... of supervision exercised by officers'); Williams v McKay 46 NJ Eq 25, 36, 18 A 824 (Ch 1889) (director under duty to supervise managers and practices to determine whether business methods were safe and proper). Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. The sentinel asleep at his post contributes nothing to the enterprise he is charged to protect: Wilkinson v Dodd 42 NJ Eq 234, 245, 7 A 327 (Ch 1886), affirmed 42 NJ Eq 647, 9 A 685 (E & A 1887).

Directorial management does not require a detailed inspection of day-to-day activities, but rather a general monitoring of corporate affairs and policies: Williams v McKay at 37, 18 A 824. Accordingly, a director is well-advised to attend board meetings regularly ....

While directors are not required to audit corporate books, they should maintain familiarity with the financial status of the corporation by a regular review of financial statements .....

The review of financial statements, however, may give rise to a duty to inquire further into matters revealed by those statements: Corsicana Nat'l Bank v Johnson [1919] USSC 223; 251 US 68 , 71; [1919] USSC 223; 40 SCt 82, 84; [1919] USSC 223; 64 L Ed 141 (1919); Atherton 99 F 2d at 890; LaMonte v Mott 93 NJ Eq 229, 239, 107 A 462 (E & A 1921); see Lippitt v Ashley 89 Conn 457, 94 A 998. Upon discovery of an illegal course of action, a director has a duty to object and, if the corporation does not correct the conduct, to resign: see Dodd v Wilkinson 42 NJ Eq 647, 651, 9 A 685 (E & A 1887); Williams v Riley 34 NJ Eq 398 at 401 (Ch 1881).....

A director is not an ornament, but an essential component of corporate governance. Consequently, a director cannot protect himself behind a paper shield bearing the motto 'dummy director': Campbell (at 443, 50 A 120) ('The directors were not intended to be mere figure-heads without duty or responsibility'); Williams v McKay at 57-58, 18 A 824 (director voluntarily assuming position also assumes duties of ordinary care, skill and judgment). The New Jersey Business Corporation Act, in imposing a standard of ordinary care on all directors, confirms that dummy, figurehead and accommodation directors are anachronisms with no place in New Jersey law. See NJSA 14A: 6-14. Similarly, in interpreting section 717, the New York courts have not exonerated a director who acts as an 'accommodation'."

102 It is appropriate to also set out observations made by Tadgell J in Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at p126:

"As the complexity of commerce has gradually intensified (for better or for worse) the community has of necessity come to expect more than formerly from directors whose task it is to govern the affairs of companies to which large sums of money are committed by way of equity capital or loan. In response, the parliaments and the courts have found it necessary in legislation and litigation to refer to the demands made on directors in more exacting terms than formerly; and the standard of capability required of them has correspondingly increased. In particular, the stage has been reached when a director is expected to be capable of understanding his company's affairs to the extent of actually reaching a reasonably informed opinion of its financial capacity. Moreover, he is under a statutory obligation to express such an opinion annually. I think it follows that he is required by law to be capable of keeping abreast of the company's affairs, and sufficiently abreast of them to act appropriately if there are reasonable grounds to expect that the company will not be able to pay all its debts in due course and he has reasonable cause to expect it."

103 I mention some insolvency cases where directors have been found to be personally liable by reason of statutory provisions for debts incurred by the company whilst insolvent. As has been mentioned, this provision has no application in the present case but observations made by the Courts as to the responsibilities of directors are pertinent.

104 In Metal Manufacturers Pty Ltd v Lewis (1988) 13 NSWLR 315, Kirby P said at pp318-319:

"The time has passed when directors and other officers can simply surrender their duties to the public and those with whom the corporation deals by washing their hands, with impunity, leaving it to one director or a cadre of directors or to a general manager to discharge their responsibilities for them. Section 219 of the Code requires that a company have at least two natural persons as directors. By s 229, the directors are obliged to exercise reasonable care and diligence. Other provisions of the Code (eg, s 269 and s 270) require the directors to address their minds to the affairs of the company. In these circumstances, the terms of s 556 must be understood to be part of an integrated legislative scheme. 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. Nor is this an aberration in local company law. It is part of a wider international movement affecting several aspects of the duties of company officers: cf E Thomas, 'Corporate Governance - the Age of Accountability' in Professional Administrator December 1983 at 203: see also the observations of Cooke J in Nicholson v Permakraft (NZ) Ltd [1985] NZCA 15; [1985] 1 NZLR 242 and Lord Templeman in Re Horsely and Weight Ltd [1982] Ch 442 at 455 (CA) and in Winkworth v Edward Baron Development Co Ltd [1987] 1 All ER 114 at 118 (HL) and comment R Baxt (1987) 5 Company and Securities LJ 247 at 248."

The other members of the Court did not see the need to discuss those general observations.

105 In Morley v Statewide Tobacco Services Ltd [1993] VicRp 32; [1993] 1 VR 423, the Court was concerned with a claim against a director who had played no part in the affairs of a small family company from the time of its incorporation until the time of its liquidation, a period of nearly 30 years, for debts incurred when the Company was commercially insolvent pursuant to a similar statutory liability as in Metal Manufacturers Pty Ltd v Lewis per Kirby P_._ She had been a director when the affairs of the Company had been administered by her late husband, and after his death by her son, both of whom were directors. Whilst the Court had to consider whether a statutory defence had been established, observations were made about the duty of a director: Ormiston J said at p448:

"What is reasonable, therefore, is related in part to the extent of the enquiries 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 enquiries. 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.

However, at the least, a director cannot now assert from a state of total ignorance that he or she had no reasonable cause to expect that a company could not pay its debts as they fell due, within the meaning of para. (b). A director may claim, exceptionally, that he took reasonable steps with the other directors to appoint suitable and appropriate accountants and other executives and that they failed to provide information when asked. If the failure to provide information be short in duration, the director may be able to show that he acted reasonably, but he cannot rest on that ignorance. Moreover, to fail to make any enquiries whatsoever is not excusable and an opinion on the company's solvency based on that ignorance could not be characterised as reasonable. Even in a small company a director should ask for and receive figures, albeit of a basic kind, on a more or less regular basis. If that is sought and it reveals no difficulties and the director has no other reason to suspect the company may not be able to pay its debts as they fall due, then the director may be shown to have acted reasonably. Directors cannot be required to make their own further investigations or to 'audit' the accounts provided, unless they have particular responsibilities or expertise, and they can only be required to seek more information if the company's accounts, together with any other information from the company's executives, put them on enquiry."

The first part of these observations was expressly accepted on appeal: see at p464.

106 As has been mentioned in Capricorn, the Full Court was concerned with the civil liability of directors for a debt pursuant to s592 of the Corporations Law and the defences available under that section. The action was brought by a creditor of the Company against the directors. Section 592 is in similar terms to the statutory basis of the proceedings in Metal Manufacturers and Morley. The Court was not specifically concerned with duties of directors under s232(4) or at common law. As has been mentioned, the directors in that case were Mr Linke, Mr Verco and Mr Hodge, although the action did not proceed against Mr Linke. However, the Court did conclude that Mr Verco and Mr Hodge were in breach of their duties to the Company in the circumstances established by the evidence in that case. Lander J, with whom Cox and Perry JJ agreed, approved of the observations as to the duty of directors of Ormiston J in Morley.

107 Lastly, I mention the duty of a director to the company, as opposed to its members, to act in the interests of the company. This requires consideration of the interests of creditors including future creditors: see Walker v Wimborne & Ors [1976] HCA 7; (1975-1976) 137 CLR 1 per Mason J at p7; Kinsela & Anor v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722 per Street CJ at p732; Lyford & Anor v Commonwealth Bank of Australia [1995] FCA 1261; (1995) 130 ALR 267 at pp283-284 and Winkworth v Edward Baron Development Co Ltd & Ors [1987] 1 All ER 114 at p118; Ford Principles of Corporations Law 8th Edition, para 8.100 and the cases referred to therein. The rationale of this duty is concisely expressed by Mason J in Walker at p7:

"Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them."

108 The plaintiff alleges that both Mr Verco and Mr Hodge abrogated all of their duties as directors in that they failed to:

1 hold or attend any meeting or sufficient meetings of directors of the Company, including any annual general meetings;

2 make a formal or sufficient enquiry as to the financial position of the Company;

3 make any examination of the books of the Company;

4 make any effort to verify information concerning the Company provided to them from time to time by Mr Linke;

5 ensure that the Company kept or maintained proper financial statements or records;

6 seek even basic information as to the financial position of the Company from time to time;

7 insist upon any record of the entry by the Company into contracts;

8 insist upon any record of the use of the seal of the Company;

9 make any enquiry at all as to whether the Company could pay all or any of its debts;

10 put implicit trust in Mr Linke concerning the ongoing running and management of the affairs of the company.

The consequence, it is alleged, is that Mr Verco and Mr Hodge acted in breach of their duties to the Company, including under s232(4).

109 It is clearly established that Mr Verco and Mr Hodge were in breach of most of these duties.

110 As has been mentioned, there was only one meeting of directors from 23rd June 1990 until the Company went into receivership, which occurred on 3rd December 1991. I have mentioned what occurred at this meeting. One directors' meeting was totally inadequate in the circumstances. There was no annual meeting of the Company for the 1990 or 1991 financial years. The annual reports and financial statements of the Company were not considered by the directors at a meeting and were not approved or adopted.

111 There were no formal enquiries by Mr Verco or Mr Hodge as to the financial position of the Company. However, that is a matter which must be put in context. They received the budgets and the accounts which have been mentioned. They received information each month of a general nature as to the financial position of the Company from Mr Linke which was always positive. The annual report for the year ending 30th June 1991, written by Mr Linke, was in positive terms. I accept that the statements made by Mr Greatbatch at the meeting on 3rd December 1991 were generally positive and an explanation was given for the absence of regular financial accounts, namely the malfunction of the new computer. In the case of Mr Verco, his interests received the payment of $20,000 which, to him, suggested the financial health of the Company. In these circumstances I do not think the absence of enquiries about the financial position of the Company from time to time constituted a breach of duty by Mr Verco or Mr Hodge.

112 However, when they became directors, they did not ask to see even the basic financial statements of the Company such as the annual statements for previous years which would have revealed the substantial debt. Even basic enquiry would have revealed the existence of the debt due to the ANZ Bank. Neither of them sought any information as to how the purchase of the two service stations had been financed and as to the capacity of the Company to meet any such financial obligations. They did not become familiar with the business of the Company and how it was conducted so that they could form a sound judgment about whether it was being properly run. They did not take reasonable steps to place themselves in a position to guide and monitor the Company. They were in breach of some of the statutory duties which have been mentioned. No minute book was kept. The accounting records, although appropriate in form, did not record the loan to the ANZ Bank and the contingent liability through the guarantee of the loan from Excel to Mr and Mrs Linke. The annual financial accounts did not accurately reflect the true state of affairs of the Company and no consideration was given to whether current assets would be likely to realise, in the ordinary course of business, their value as shown in the records of the Company. Appropriate accounting standards were not complied with in the presented accounts in that, at the least, there was no provision for amortisation of goodwill and inadequate provision for depreciation.

113 Neither Mr Verco nor Mr Hodge examined the books of the Company at any time or sought to verify information about the Company which had been provided to them by Mr Linke. They did not take any steps to ensure that the Company maintained and kept proper financial statements or records. They were aware that Mr Veitch was the accountant retained by the Company and that the Company had also retained a solicitor and that the Company employed Mr Linke and Mr Greatbatch but these matters did not absolve them of the fundamental duties which have been mentioned.

114 The evidence also establishes that Mr Verco and Mr Hodge did not insist upon any record of entry by the Company into contracts or the use of the Company's seal. Had they done so, they would have been aware of the contracts for loans, the guarantee of the Excel loan and the terms of the purchase of the service stations, including the provision of vendor finance. Without question, they put their trust in Mr Linke as to the running and management of the Company.

115 It is submitted that Mr Verco was under an obligation to consider the terms of the purchase of the Salisbury Downs and Para service stations and should have made reasonable enquiries accordingly. The nature of those enquiries should have included the nature of the assets of the business, their cost and value as well as the value and amortisation of goodwill and depreciation of the assets. The terms of the franchises should have been ascertained and considered.

116 Enquiries should have been made as to the working capital and other assets which the Company required to run the service stations and how the Company would fund the total costs of acquiring the business and of commencing trading. It was also submitted that Mr Verco should have ascertained the interest cost to the companies of the necessary borrowings and the requirements for the repayment of principal and the profit which the Company would have to make to pay that cost. Mr Verco did not make any of those enquiries. I return to aspects of those matters later but he was in breach of his duty as a director in not making some of those enquiries.

117 The plaintiff submits that Mr Verco did not monitor the financial position of the Company at any time after the settlement of the purchase of the service stations on 4th July 1991 until Mr Hodge and Mr Siegle became directors in May 1991. Having made no enquiries about the financing of the purchase, he did not enquire about the vendor finance and repayment of it. He did not analyse the accounts of September 1990 or December 1990 and did not consider interest expenses, depreciation or amortisation and compare them to the budget. As has been mentioned, there were no directors' meetings until December 1991 and he did nothing to guide or oversee the management of the Company and, in particular, the decisions of Mr Linke and Mr Greatbatch. He did not discharge his statutory duty to call for, and consider, the financial statements of the Company to 30th June 1990. Mr Verco was in breach of his duty as a director in relation to most of these matters. The acquisition of the service stations and the financing of that purchase were matters essential to the future of the Company and its ability to exist.

118 The plaintiff also submits that Mr Verco was under an ongoing obligation to assess the solvency of the Company after the purchase of the service stations. As has been seen, his duty to the Company includes a duty to investors and financiers. Very large sums of money had been lent to the Company by the ANZ Bank and the Bank of Singapore. Those lenders were entitled to expect competent management of the Company and that the directors would discharge their duties adequately. Mr Verco did not make any enquiries and was content to rely upon information given to him by Mr Linke and in a most general manner.

119 It is submitted that Mr Hodge should have called for, and considered, the financial statements of the Company to 30th June 1989 before or immediately after becoming a director for the same reasons as Mr Verco was obliged to do so. In my view, he was obliged to do so and also to consider the accounts to 30th June 1990 so as to generally familiarise himself with the position of the Company at the end of the most recently completed financial year. A prudent director, let alone one who was also an investor, should seek the financial accounts for a number of previous years. I do not think that is an obligation, per se, which is assumed merely because a person becomes a director. However, a director, in Mr Hodge's position, was under an obligation to ascertain the true financial position and health of the Company in order to be able to carry out his duties as a director competently and in the present circumstances. Perusal of the annual accounts for the 1989 and 1990 years was required for that purpose, particularly because of the accumulated losses of which he was aware. I think he should have made much the same enquiries as should have been undertaken by Mr Verco and which have been discussed.

120 It is submitted that both Mr Verco and Mr Hodge were obliged to urgently obtain and consider the financial statements of the Company to 30th June 1991 because of the poor financial position of the Company at that time. Whilst it is true that the Company had not met deadlines for payment to the Bank of Singapore at the end of each of the months of January, May and June 1991, those payments were made and there was no reasonable basis for apprehending that the Company was experiencing difficulties at that time. Later I mention the significance of the debt to the ANZ Bank. I do not think Mr Verco or Mr Hodge were obliged to call for these statements to be prepared and to consider them as a matter of urgency.

121 However, having considered all of these matters, I conclude that Mr Verco and Mr Hodge were in breach of their duties pursuant to s233(4) and at common law. In making that finding, I have had regard to their being non-executive directors and to their understanding of the competence and reliability of Mr Linke. They took no steps to inform themselves about the affairs of the Company, or to become familiar with the service station businesses and how they were run in the general sense. The extent to which they, as non-executive directors, were justified in trusting and relying upon Mr Linke as the chief executive officer or managing director and Mr Greatbatch as a senior administrator depends upon the nature and circumstances of the Company as they existed, not as Mr Verco and Mr Hodge thought them to exist. This is so because of their failure to inform themselves about the affairs of the Company. Had they done so and found it to be financially healthy and well managed with appropriate procedures for reporting through the chief executive officer to the board of directors, it may be expected that they could have left many matters to Mr Linke and staff of the Company without being in breach of their duty as directors. They were content to leave the management of the Company entirely to Mr Linke with having made any relevant enquiries about the Company, including its financial position, management structure and business. However, such was not the case. Whilst it may be accepted that as non-executive directors they were not under an obligation to carry out a detailed inspection of the day-to-day activities of the Company, they were obliged to be aware of the true financial position and capability of the Company and to act appropriately if there are reasonable grounds to expect that the Company will not be able to pay its debts: Friederich at p126.

122 Whilst the Company was not a public company and the only shareholders were the investors or entities which they controlled, it had large debt. Those lenders were entitled to expect that the Company would be managed appropriately and the directors were obliged to do so.

123 The basis upon which both Mr Verco and Mr Hodge became investors in the Company cannot relieve them of their duty to the Company. It will be remembered that Mr Verco told Mr Linke that he did not want to be involved in the running or management of the service stations and that Mr Hodge told him that he knew nothing about the running of service stations and would expect to be a sleeping partner. Both men agreed to become directors and were obliged to discharge their duty as directors. Although it has no bearing upon their responsibility, both men obtained advice from their accountants before accepting the position of directors. The extent of that advice was not revealed, but it may be expected any competent adviser would, in the circumstances, have advised, at least in a general way, about their duties as directors. However, even if they were not so advised, they accepted the positions and the attendant duty.

124 It was submitted that both Mr Verco and Mr Hodge are farmers with little commercial experience which was known to Mr Linke. They believed Mr Linke to be a person of substance with substantial assets and a very successful businessman. It may be accepted that Mr Linke enjoyed such a reputation among others. He held responsible positions in the horse racing industry. He had been able to borrow substantial funds from different financial institutions. In an internal memorandum dated 30th July 1990 to the office in Melbourne, the State Manager of the Bank of Singapore reported, "we are dealing with first class people and strongly recommend approval to provide the additional $100,000 for the short term required". It was at this time that the further loan was obtained. However, whatever his reputation and how Mr Verco and Mr Hodge regarded him, they were not relieved from their obligations as directors. Also, the evidence establishes that both men were capable of discharging their duties. They were not men ignorant of financial matters brought on to the board to provide some other expertise. Their farming business required some commercial expertise. They were committee members of racing clubs handling, I expect, significant sums of money and were called upon to participate in commercial decisions from time to time. Perusal of transcripts of their evidence in the Capricorn case reveal a degree of business knowledge and acumen.

125 For these reasons, I conclude that they were in breach of their duties to the Company as directors pursuant to s232(4) and at common law.

126 It is the plaintiff's case that if the directors had caused the Company to cease trading at 1st July 1991, substantial losses would have been avoided. The extent of those losses requires careful consideration of a substantial body of evidence which is unnecessary to explain the nature of the case against Mr Verco. The losses are said to be not less than $400,000. The plaintiff's case is that the Company was insolvent before the two service stations were acquired in 1990 and remained insolvent thereafter. Had Mr Verco and Mr Hodge discharged their duties as directors they would, or should, have ascertained this state of insolvency and the continuing losses of the Company and taken appropriate steps available to them which would have avoided the further losses. They should have taken one or more of the following courses of action: caused the Company to cease trading and be wound up; applied for the appointment of a provisional liquidator or a receiver; reported the circumstances to the Corporate Affairs Commission and requested it to investigate and take such action as was appropriate; notified the secured creditors of the state of affairs of the Company, particularly as there had been breaches of the terms of the arrangements between the Company and creditors or events of default or matters which were otherwise required to be notified; called a meeting of the members of the Company to consider and vote on appropriate action; resign; or, call up their loans.

127 The plaintiff must establish that a breach, or breaches, of duty as directors by Mr Verco or Mr Hodge caused the losses incurred by the Company.

128 The first matter to consider is whether, at relevant times, the Company was insolvent. If so, the directors could be in breach of duty to the Company in allowing it to incur further debt. The circumstances in the present case are unusual. As has been seen, immediately prior to the acquisition of the two service stations in July 1990, the Company had no business, no income and no assets of any significance. It had a substantial debt to the ANZ Bank due to the commercial activities of Mr and Mrs Linke. It could not be doubted that the Company was insolvent at that point of time.

129 However, the position changed when the two service stations were purchased. That purchase occurred with the knowledge and approval of the only creditor, the ANZ Bank. That Bank was looking to Mr and Mrs Linke to pay the loans and was expecting them to do so from their own assets which remained the position at all times thereafter. As has been seen, the purchase price was to be financed from another source, namely through the loan from the Bank of Singapore and investment by Mr and Mrs Linke and others. The ANZ Bank agreed with the proposal and allowed its security over the assets of the Company to be taken by the Bank of Singapore which occurred upon Mr Linke paying $86,000 to the ANZ Bank. That Bank allowed the loan to continue for an unspecified time whilst Mr and Mrs Linke put their affairs in order. It allowed the loan to continue so that the two service stations could be purchased and operated to the benefit of the Company and Mr and Mrs Linke with a consequential benefit to itself.

130 No one from the ANZ Bank gave evidence and so the attitude of that Bank can only be ascertained from the documents admitted into evidence and the surrounding circumstances which have been proved. There was an obvious benefit to the ANZ Bank in allowing the Company to purchase and operate the service stations. The shares held by Mr and Mrs Linke could increase in value. Mr Linke could earn income. The Company could become profitable. All of these matters improved the chances of the ANZ Bank in recovering all or part of the loan due. I do not think there can be any doubt that in permitting the purchase of the service stations, the ANZ Bank was acting in its own interests.

131 As has been seen, the balance of the purchase price had to come from investors. The Excel loan was made to Mr and Mrs Linke to enable them to contribute to the Company. It was not a loan to the Company. Other funds come through Mr Verco, Mr Hodge and Mr Siegle. At all relevant times they allowed the loans made through them to continue with the consequence that the Company could continue trading.

132 The Bank of Singapore continued the financial accommodation provided by it until the Company went into liquidation. It increased that accommodation from time to time. It was paid the interest due by the Company until shortly before the appointment of the managers and receivers. No one from the Bank of Singapore gave evidence but it may be accepted that it continued, and increased, the financial accommodation to the Company to enable it to trade.

133 In the trading sense, the Company made a profit at relevant times and it may be said that there were only substantial losses if items of interest on the loan to the ANZ Bank and the non cash items of amortisation of goodwill and depreciation, were brought fully to account.

134 Insolvency is a term which is well understood. A person is insolvent if unable to pay his or her debts as they became due: see Rees v Bank of New South Wales [1964] HCA 47; (1964) 111 CLR 210, Queensland Bacon Pty Ltd v Rees [1966] HCA 21; (1965-1966) 115 CLR 266 and Sandell v Porter & Anor (1966) 115 CLR 666. Insolvency is a question of fact. In Standard Chartered Bank of Australia Ltd v Antico & Ors (1995) 131 ALR 1, Hodgson J said at p71:

"......... it is necessary to consider the company's financial condition in its entirety, including its activities, assets, liabilities, cash, money which it could procure by sale or on the security of its assets, and its ability to obtain financial assistance by way of loan or subscription for share capital."

His Honour went on to cite authority, including Rees and Sandell v Porter and said:

"The question is one of ability to pay, not fact of payment; so even if, for some reason, there were reasonable grounds to expect that the company would not in fact pay all its debts as and when they became due, this would not, of itself, be enough. So long as there were not reasonable grounds to expect that the company would not be able to pay its debts as and when they became due, it would not matter that there were reasonable grounds to expect that the company would not in fact pay its debts, because, for example, it saw it as being to its own advantage to delay payment.

Next, there is no requirement in this provision that the payment of debts should come from the company's 'own money', as in certain provisions of the bankruptcy Act."

In those cases the Courts were considering the "ability to pay one's debts as and when they became due" in the context of particular legislation but the expression is synonymous with solvency. Prior J considered the meaning of this expression in Powell & Duncan v Fryer, Tonkin & Perry (14th April 2000, [2000] SASC 97, unreported). It is instructive to consider the following passage of His Honour's reasons for judgment at p2:

"It must be acknowledged immediately that there is no specific reference to or requirement in this section that debts must be payable from the company's own money. In this respect the liquidator's conclusion must be modified and the effect of his evidence and opinion judged against a proper interpretation of the relevant statutory provisions. Access to money of other persons is not an irrelevant consideration in determining whether or not a company is insolvent (cp Standard Chartered Bank v Antico (1995) 131 ALR 1 at 71). The commercial solvency of a company is not proved by merely looking at its accounts and making a mechanical comparison of its assets and liabilities (Sandell v Porter (1966) 115 CLR 666 at 670 applied in Carrier Air-Conditioning v Kurda (1993) 11 ACSR 247 at 258). Insolvency is a question of fact falling to be decided as a matter of commercial reality in the light of all the circumstances with things being viewed as it would be by someone operating in a practical business environment. The statutory focus is on solvency, not liquidity. Thus it is appropriate to consider the terms of credit or financial support available to the company with which to defray any debts owed to creditors. The question is not to be answered merely by looking at the financial statements (Brooks v Heritage Hotel Adelaide (1966) 20 ACSR 62 at 64; Standard Chartered Bank v Antico)."

135 In my view, those observations are pertinent to consideration of whether the Company was solvent. As has been seen, the Company traded under the stewardship of the directors from the time of the acquisition of the service stations until the appointment of the managers and receivers by the Bank of Singapore. The financial accommodation of the ANZ Bank in the manner mentioned and the Bank of Singapore permitted the Company to do so. When loans due to the Bank of Singapore were not repaid, they were extended. No evidence was led as to why these financiers took this course but the reason seems obvious. It is likely that each of them concluded that the prospect of recovery rested in the continuing trading of the business by the Company and by Mr and Mrs Linke realising their assets favourably. As has been seen, there were occasions when the Company was late in making payments to the Australian Tax Office and to the Bank of Singapore and some cheques were dishonoured, but all of these payments were made and are not indicators of insolvency.

136 Without question, the Company would have been insolvent if the ANZ Bank or the Bank of Singapore had called up their respective loans, which did not occur, and the Company was unable to obtain finance elsewhere. The onus of proving insolvency rests with the plaintiff. He sought to do so by his evidence and his report which was admitted into evidence. It is fair to say that the plaintiff has approached the question of insolvency by the comparison of assets and liabilities and consideration of the loans. As has been seen, that approach is inadequate. The plaintiff regarded the inability to pay loans from the ANZ Bank, the Bank of Singapore and Excel as establishing insolvency.

137 I mention some further matters about these loans. At no time did the ANZ Bank ever seek payment of the loan from the Company only from Mr and Mrs Linke. At no relevant time did payment of this loan by the Company become due.

138 When the Company sought from the Bank of Singapore extension of the time for payment of the loans in July 1991 to 31st July 1992, the State Manager of the Bank in his report wrote that all commitments to the Bank had been met in the past and he could see no reason not to extend the existing facilities for twelve months to enable Mr Linke to sell property. Also he concluded his report with a "strong recommendation" for the removal and increase of the loans. Whilst the Company did not make some payments of principal as required by the Bank of Singapore, those requirements were extended and then renewed. There was no demand by the Bank of Singapore at any relevant time for repayment of the loans and no such repayments became due.

139 It appears that the Company paid interest on the loan from Excel up to September 1991 even though the loan had been made to Mr and Mrs Linke. No payments were made by the Company after 4th September 1991. No evidence was led to explain why those payments were made by the Company and not by Mr and Mrs Linke. After default by them, there is no evidence to establish that Excel had called upon the Company to make the payments pursuant to the guarantee. Even if the payments were made pursuant to the guarantee, which is unlikely, the accounts of the Company should have reflected the right of indemnity from Mr Linke as an asset of the Company which, at that time, given his ownership of assets, should have been represented as having at least the value of the amounts paid by the Company. The plaintiff did not have regard to that matter.

140 At 1st August 1991 the interest payments to Excel were up to date and Excel extended the loan to 1st August 1992 with the requirement to make the repayments of principal by instalments of $25,000 each quarter commencing on 30th September 1991 as has been mentioned. The Excel loan was not due at the time of the extension. No payments were made to Excel of principal or interest as from 30th September 1991. It appears to have been conceded that the Excel loan became due to be paid by the Company at that stage pursuant to the guarantee. No analysis was made by the plaintiff of the capacity of the Company to make the payments after August 1991 which were not made. There is no evidence of any demand having been made by Excel to the Company or to Mr Linke. I have not regarded the fact of payments not being made by the Company to Excel as evidence of insolvency.

141 The plaintiff asserted that the Company did not make payments of statutory levies to Workcover for the period from 1st November 1991 or of fines imposed by Workcover for late payments from 1st September 1991. Also the Company did not make payments to the Australian Taxation Office after October 1991. These defaults may be some evidence of an inability to pay debts, but they do not prove insolvency. They may be evidence of no more than the payments not being made for some unexplained reason. In the absence of evidence of the reason, I have not regarded these defaults as establishing insolvency.

142 For these reasons it has not been established that the Company was unable to pay debts as they became due and consequently I have not found the Company to have been insolvent as alleged.

143 Mr Verco and Mr Hodge have not been shown to be in breach of their duty to the Company in that respect as pleaded. The Company continued to trade, and apparently profitably, but without the capacity to meet the obligations under the loans due to the ANZ Bank and the Bank of Singapore and Excel, if there was any obligation to pay that loan. The Company did not become insolvent until any one of these financiers withdrew support.

144 It appears from the judgments in Capricorn that the evidence in that case established that the debt due to Capricorn was incurred between November 1991 and March 1992 and that when it was incurred, there were reasonable grounds to expect that the Company would not be able to pay all of its debts as and when they became due. I am not aware of the evidential basis for that finding. That finding is not binding upon me and is not a finding which I could make on the evidence in the present case.

145 It remains to consider whether the breaches of duty which have been established were otherwise causative of losses incurred by the Company. It is necessary to consider what may have been the position if they had not been in breach of those duties. They would have been aware of the loans and the terms of the loans. They would have obtained, after insistence, regular financial accounts, reports and budgets, similar to those which were given to them and which have been mentioned. As has been seen, the budgets were extremely favourable, the accounts or reports showed profits. At all times Mr Linke spoke favourably about the Company and so did Mr Greatbatch when called upon to do so. At the meeting of directors on 3rd December 1991, the reports were again favourable and were given in the presence of the Company's accountant and solicitor.

146 When considering what would have been ascertained if they had gone behind those accounts and reports, it is appropriate to have regard to the evidence of Mr Irving and Mr Tom Verco.

147 Mr Irving is a chartered accountant who has worked in the field of insolvency since 1980. He has been a registered liquidator since 1988 and he is a partner in the firm known as Arthur Andersen. I accept him as a competent, truthful and reliable witness.

148 Mr Linke had approached the Bank of Singapore regarding his financial position in early 1992 and had arranged an informal meeting of his creditors. Mr Irving was instructed by the Bank of Singapore to assist in the assessment of the impact of that proposal upon the Bank. Mr Irving undertook that task and was then instructed to review the Company and its businesses. Upon undertaking that task, he reviewed the historical financial statements and prospective profit and loss budget and cash flow forecasts for the businesses.

149 As has been mentioned, the profit and loss statement of the Company for the year ending 30th June 1991 showed a net profit of $35,491 and the balance sheet showed a deficiency of assets of $464,710. The profit and loss statement for the period ending 31st December 1991 showed a net profit of $92,327.65. The balance sheet showed a deficiency of assets of $372,382. It appears that Mr Irving saw no reason to question these amounts except in one respect which is not relevant for present purposes. Also he reported to the Bank of Singapore that from the information available and investigations made, the budgets and cash flow forecasts for the year ending 31st December 1992 were achievable. Those forecasts were for a substantial net profit, in the order of $234,000 for the Company and $62,000 for Batmass. Furthermore Mr Irving, with his expertise and experience, decided that the Company should continue to trade.

150 It is convenient to mention at this stage documents purporting to be financial accounts for the period ending 31st December 1991.

151 The plaintiff objected to the admission into evidence of the balance sheet and profit loss statement for the period ending on 31st June 1991 to which reference has been made and which was considered by Mr Irving and Mr Tom Verco. It is in the form of a computer print out and bears the date of 10th January 1992. The defendants assert that they are management accounts of the Company. The first ground of objection is that these documents are irrelevant to any facts in issue as the breaches of duty alleged against Mr Verco and Mr Hodge had all occurred by the middle of 1991. I reject that contention. The financial state of the Company for the period ending 31st December 1991 is relevant to matters in issue as has been seen.

152 The second ground of objection is that no weight may be given to the accounts as a business record due to the absence of any safeguards in respect of it. Mr Blue contended that there was no proof that it was used by the Company in the course of its business to record in a permanent way its position on performance, as opposed to being a print out of an incomplete draft on a computer. Admissibility of a document or documents as a business record is pursuant to s45a of the Evidence Act 1929. Section 45a(4) provides that a "business record" means:

(a) any book of account or other document prepared or used in the ordinary course of a business for the purpose of recording on matters relating to the business; or

(b) any reproduction of any such record by photographic, lithographic or other like process.

SHEAHAN AS LIQ SA SERVICE STATIONS v VERCO & HODGE No. SCCIV-96-1303 [2001] SASC 91

At a glance

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Decision date

Before

Source

Judgment (216 paragraphs)

SHEAHAN AS LIQ SA SERVICE STATIONS v VERCO & HODGE No. SCCIV-96-1303 [2001] SASC 91 (29 March 2001)

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Legislation Cited (2)

Cases Cited (12)