Mrs Clark's defence - the facts
84 In view of my findings as to the construction of the Deed of Release and as to estoppel, Mr Clark has no further defence to the DCT's claim under CA s.588FGA(2). Mrs Clark's sole remaining defence to the claim is that afforded by CA s.588FGB(5), i.e. that, for some "good reason", she did not take part in the management of SCI between 30 April and 30 September 1997. The relevant facts may be shortly stated. They are not in dispute.
85 Mr Clark is a carpenter by trade. For three or four years prior to 1994 he was a director of a company which was a fit-out contractor. That company went into liquidation. In 1994 he and three friends started another business doing small fit-out jobs. They incorporated SCI on 3 November 1994.
86 For some reason not explained in the evidence, Mr Clark was not an initial director of the company. He became a director only on 1 May 1996. Mrs Clark, however, became a director on 23 August 1995. That was the date upon which one of the two then-current directors, Mr Donohoe, resigned. Mr Clark was appointed as a director when another director resigned, leaving Mrs Clark as sole director. Mr Clark's evidence as to how Mrs Clark came to be a director of SCI was that when one of the directors resigned, he believed that the company required two directors, so he asked his wife to become a director. He said to her words to the effect:
"I just need you to be a director because I need two directors."
87 He said that after Mrs Clark became a director of SCI he never discussed the affairs of the company with her. He never showed her any documents relating to the company's affairs, such as its financial accounts, because he did not want "to stress her out" . He explained what he meant:
"And when I say I didn't want to stress her out, I don't mean because of the accounts, I mean I didn't tell her anything because she - I carried a lot of stress just in the operation of the whole thing, and I didn't take work home at all. And, you know, because she could see that running the company was very time consuming, and a lot of pressure deadlines to finish fit outs for companies to move in, and there was always constant pressure, and so I didn't - very rarely spoke about work at home. When I got home it was just, you know, time together, time out. And so this is why I wouldn't have shown her any accounts because she just wouldn't be interested. She just didn't want to know."
88 Mrs Clark's evidence was that she had been carrying out home duties full time since the birth of the first of her three children in 1992. Before that, she had worked as a secretary but her main interest was in creative areas. She had done singing for recording sessions and in 1997 her hobby was writing and putting together a children's production involving a musical programme for performance in shopping centres. She conducted that hobby from her home when time permitted. She had had no business experience and had never been a company director before being appointed as a director of SCI. At the same time, she had also been appointed as secretary of the company but could not recall being so appointed or how that appointment had come about.
89 Mrs Clark gave this evidence as to how she had been appointed a director of SCI:
"Q: How was it that you came to be a director of the Company?
A: My husband just wanted me to be. As I understood it there was a requirement that there be two directors in the Company and I was to be one of them."
…
Q: Clearly you had to sign various documents when you became a director, did you?
A: Yes.
Q: What did you think becoming a director of the Company involved or entailed?
A: Well I just thought it was what I had to do, being Robert's wife, and I was quite happy to do that.
Q: Had you not been a director of a company before?
A: No.
Q: So this was the first time you had been a director?
A: Yes.
Q: Did you understand that being a director involved paying some care and attention to the running of the Company or not?
A: I do now. At the time I left it to Rob.
Q: I understand that, but I am really focussing on what you thought you should do at the time?
A: I thought I should let Rob run it and I signed papers to be honest.
Q: Is that in fact how your involvement unfolded, your husband Robert would bring home documents?
A: Yes.
Q: And did you look at them at all in terms of signing or did you simply just sign the documents put before you?
A: Sometimes I would look and, honestly, the amount of time that it would have taken to sit down and fully understand! He would quickly say 'This is such and such. Can you sign this?' I would usually have [a] frying pan in one hand and be signing [with] the other."
90 Mrs Clark also said that she never had any idea of the balance in the company's cheque account although she believed that she was a signatory to the account and signed "a handful" of cheques at some stage. She never did any banking or other work for the company. She never saw a balance sheet. She was aware that Mr Armstrong was the company's accountant and was advising Mr Clark as to the conduct of the business. She was aware that the company employed carpenters, possibly four men, whom she would see regularly because they were friends. Mrs Clark ceased to be a director of the company on 3 June 1997 because Mr Clark then became aware that it was no longer necessary for a company to have two directors. That, as Mrs Clark described it, was the full extent of her involvement with SCI's business.
91 This evidence of Mrs Clark was not challenged by Mr Aitken and I have no hesitation in accepting it. Mrs Clark struck me as a lively, creative person who was devoted to her family. It was clear from her evidence and her demeanour in Court that she trusts her husband implicitly.
92 When asked about her appreciation of her duties and responsibilities as a director of SCI when she accepted the appointment, Mrs Clark gave this evidence:
"Q: … did you have any idea whether the law imposed any duties upon company directors?
A: No, I didn't.
Q: And required …
A: No, I didn't, your Honour.
Q: Did you have any idea when you became a director of Southern Cross what was involved in being a director of a company?
A: No, I didn't, no, but I knew that Rob did.
93 As to when it was that she was told that SCI was in financial trouble, all Mrs Clark could say was that she recalled her husband telling her that the company was in difficulty and talking about Mr Palmer in that context. Mr Palmer having been appointed as administrator on 30 September 1997, it seems a reasonable inference that Mr Clark told his wife about the company's problems and Mr Palmer's appointment in August or September 1997, at the earliest - well after her resignation in June 1997.
94 I am satisfied on the evidence that in accepting appointment as a director of SCI Mrs Clark acted at her husband's request, relying entirely on his implied assurance that her appointment was a formality because the company needed two directors. She thought that that was what she had to do as Mr Clark's wife and she was happy to comply with his request.
95 I am satisfied that Mrs Clark left the management of SCI entirely to Mr Clark and that she did so, again, because she believed that as Mr Clark's wife that was what she should do. She did not know what was involved in becoming a director of the company but believed that her husband did know. I infer that Mrs Clark trusted Mr Clark to the extent that she believed that, in asking her to become a director in name only, he would not deliberately place her at risk in any way without telling her.
96 I am satisfied that Mr Clark did not ask his wife to become a director for any reason other than that he thought it was a necessary formality that SCI have two directors. He did not withhold information as to the affairs of the company from his wife for any sinister purpose but, rather, out of consideration for her and because he thought that it was his role to accept the responsibility of providing for his family without burdening his wife with his business worries. In short, I am entirely satisfied that, in acting as they did, both Mr and Mrs Clark honestly believed that there was nothing improper or untoward in Mrs Clark taking no part at all in the management of SCI.
97 The critical question is: do those findings on the facts afford Mrs Clark a "good reason" for not participating in the management of the company so that she succeeds in her defence under CA s.588FGB(5)?
Mrs Clark's defence - legal principles
98 Pt 5.7B Divisions 2 and 3, which deal respectively with voidable transactions and insolvent trading, were introduced into the Corporations Law by amendments taking effect on 23 June 1993. The amendments significantly changed the law relating to directors' liabilities for transactions entered into by a company which becomes insolvent.
99 Subsections (3) to (7) of s.588FGB afford the same defences to a claim by the DCT for indemnity under s.588FGA as are afforded by subsections (2) to (6) of s.588H to a claim for insolvent trading under s.588G, s.588M and s.588R. As almost all of the relevant authorities discuss claims against directors for insolvent trading, it is convenient to examine the construction and application of s.588H and s.588G and their antecedents. For this purpose, a brief review of the origins of the present s.588G and s.588H is necessary. A detailed history of the insolvent trading provisions in the companies legislation is traced by Lander J. in Capricorn Society Ltd v Linke (1996) 14 ACLC 431.
100 The liability of a director for insolvent trading was first introduced into Australian companies legislation by s.303(3) of the Uniform Companies Acts . That section imposed criminal liability, but not civil liability, on an officer of a company who was knowingly a party to the contracting of a debt when the officer had no reasonable or probable ground for expecting that the company would be able to pay that debt. The difficulty of securing a conviction for an offence under the section, illustrated by the course of the proceedings in Shapowloff v. Dunn (1981) 148 CLR 72, led to the repeal of the section in 1972 and its replacement by s.374C and the insertion of s.374D, which enabled a creditor to obtain an order requiring an officer convicted of an offence under s.374C to make payment of the relevant debt to the company. To secure a conviction under s.374C the prosecution still had to prove beyond reasonable doubt that the officer had no reasonable or probable grounds for expecting that the company would be able to pay the relevant debt. Proof of that element of the offence involved a blended subjective and objective test, namely, the application of the objective standard of reasonableness to the facts actually known to the officer: Shapowloff v. Dunn (supra) per Wilson J. at 85.
101 Section 556 of the Companies Code s was very different from its predecessors under the Companies Acts . A creditor was afforded a direct remedy against a director or person concerned with the management of the company. Under s.556(1), liability for the payment of a creditor's debt was imposed on all directors and others taking part in the management of the company if, at the time the debt was contracted, there were reasonable grounds to expect that the company would become insolvent. Section 556(2) provided a defence if the defendant proved that the relevant debt was incurred without his express or implied authority or consent or that, at the time when the debt was contracted, he did not have "reasonable cause" to expect that the company would become insolvent. Section 592(1) and (2) of the Corporations Act , the successors to s.556(1) and (2) of the Companies Codes , were in almost identical terms.
102 At first there was a conflict in the authorities as to the test to be applied in determining whether a director had no "reasonable cause" to expect insolvency for the purposes of a defence under s.556(2)(b). In Ellston (supra), Kemish (supra), John Graham Reprographics Pty Ltd v. Steffens (1987) 12 ACLR 779, and Heide Pty Ltd v. Lester (1990) 3 ACSR 159, the Court applied the blended subjective/ objective test formulated in Shapowloff v Dunn (supra), i.e., whether on the facts actually known to the director or officer it was objectively reasonable not to expect insolvency.
103 However, this was not the approach adopted by Hodgson J. (as he then was) at first instance in Metal Manufacturers Ltd v. Lewis (1986) 11 ACLR 122. His Honour came to the view that the reasoning in Shapowloff v Dunn (supra) as to the test to be applied to a prosecution under s.303(3) of the Companies Acts was inappropriate to be applied to a defence advanced under s.556(2)(b) of the Code . His Honour held that in deciding whether or not a director or officer had "reasonable cause" not to expect insolvency for the purposes of s.556(2)(b), the Court could have regard not only to facts and circumstances actually known to the defendant but also to facts and circumstances which the defendant ought to have known, having regard to the defendant's position in the company and to the duties associated with that position (at p.129). The case was taken on appeal but not upon this point.
104 The approach of Hodgson J. in Metal Manufacturers was adopted by Ormiston J. in Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423. At 448 his Honour said:
"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 … 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."
105 The decision of Ormiston J. in Morley was upheld on appeal and was followed by Tadgell J. in Commonwealth Bank of Australia v. Friedrich (1991) 5 ACSR 115. The same approach was taken by Lockhart J. in Rema Industries & Services Pty Ltd v. Coad (1992) 7 ACSR 251, and by the Full Court of South Australia in Group Four Industries v. Brosnan (1992) 59 SASR 22. At p.74 of the judgment of Debelle J. in the latter case, his Honour said that it would be absurd for a defendant to be able to establish a defence under s.556(2)(b) simply on the basis of what he in fact knew "because that would be to reward the incompetent director who ought to have known a good deal more than he in fact knew" . In Linke (supra) the Full Court of South Australia applied Morley and Brosnan to a defence under the successor to s.556(2)(b), namely, CA s.592(2)(b) which was, as I have noted, in virtually identical terms.
106 Sections 588G and 588H differ significantly from s.592. The sections provide, in so far as is presently relevant, as follows:
"588G(1) This section applies if:
(a) a person is a director of a company at the time when the company incurs a debt; and
(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be. …
(2) By failing to prevent the company from incurring the debt the person contravenes this section if:
(a) the person is aware at that time that there are such grounds for so suspecting; or
b) a reasonable person in a like position in a company in the company's circumstances would be so aware.
…"
"588H(1) This section has effect for the purposes of proceedings for a contravention of subsection 588G(2) in relation to the incurring of a debt (including proceedings under s.588M in relation to the incurring of the debt).
(2) It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.
(3) Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time the debt was incurred, the person:
(a) had reasonable grounds to believe, and did believe:
(i) that a competent and reliable person (the other person) was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and
(ii) that the other person was fulfilling that responsibility; and
(b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debt that it incurred at that time.
(4) If the person was a director of the company at the time the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.
(5) It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.
…"
107 It will be seen that the sections endeavour to codify some of the glosses which have been placed by the cases upon s.556 of the Code and CA s.592. Subsection 588G(2), which came into effect on 13 March 2000, enacts, by way of amplification to subsection (1)(c), that the test for "reasonable grounds for suspecting" insolvency is either a subjective test, i.e., actual awareness of grounds for suspicion of insolvency, or the objective test propounded in Lewis (supra), Morley (supra) and Friedrich (supra), namely, whether a reasonable person in a like position in a company in the company's circumstances would have been aware of grounds for such suspicion.
108 Subsection 588H(2) retains the substance of the defence afforded by s.556(2)(b) and CA s.592(2)(b), merely substituting "reasonable grounds" for "reasonable cause" and, as to the expectation of solvency, casting into positive form what is expressed as a double negative in the antecedent subsections. If a director relies upon a defence under CA s.588H(2) the law as expressed in Lewis , Morley , Friedrich , Brosnan and Linke will still be applicable. The defence will fail if it is shown that the director's expectation of solvency was the result of self-induced ignorance or failure to make such enquiries as a reasonable and competent director would make.
109 Subsection 588H(3) is, as its prefatory words indicate, a defence additional to that afforded by subsection (2). It provides exculpation for the director who has "reasonable grounds" for reliance on information provided by others as to the company's solvency. That defence acknowledges the observation of Ormiston J. in Morley (supra, at 488) that directors are not required to be omniscient and are not presumed in all cases to be fully engaged in the company's affairs. His Honour was of the view that a director may be able to prove a defence under s.556(2)(b) by showing that he or she took reasonable steps with the other directors to appoint suitable and appropriate accountants and other executives, and that those persons failed to provide information when asked.
110 The defences afforded by subsections (2) and (3) will, in many cases, overlap. Reasonable reliance on information provided by apparently competent executives or auditors may justify an expectation of solvency for the purposes of both subsections. But the defence afforded by subsection (4) is, clearly, quite different in character and scope from the defences afforded by subsections (2) and (3). A person who has not taken part in the management of the company at the relevant time cannot claim to have actually expected solvency, or to have had reasonable grounds for expecting solvency, for the purposes of a defence under subsections (2) or (3). Ordinarily, such a person would have had no grounds at all for expecting anything as to the company's financial position during the time of non-participation. Yet subsection (4) affords such a person a defence if his or her non-participation is for "some good reason".
111 The subsection doubtless has its origin in the remarks of Foster J. in Kemish (supra, at 377) and Hodgson J. in Lewis (supra, at 129) that considerations such as illness or absence could be taken into account in assessing whether a director had no reasonable grounds to expect insolvency for the purposes of a defence under s.556(2)(b). Under that subsection a director had to prove a negative, namely, absence of an expectation of insolvency. Justifiable non-participation in management at the relevant time was clearly relevant to proving ignorance of facts which would have reasonably grounded such a suspicion in the mind of a person who was participating in management.
112 Under s.588H(2) a director must now prove a positive, namely, that he or she had an actual and reasonable expectation of solvency. Non-participation in management at the relevant time would normally make such a defence impossible. The defence under subsection (4) is, therefore, a special defence which stands independently of those afforded by subsections (2) and (3). One must be careful not to treat a defence under subsection (4) as merely a sub-species of the defences under subsections (2) and (3).
113 The first matter of significance to note is that, unlike subsections (2) and (3), subsection (4) does not engage the test of reasonableness. The subsection does not require, as it might have done, that a director show "reasonable cause" or "reasonable grounds" for not participating in management. If the test of reasonableness had been engaged, it would have been necessary to enquire by what standard of conduct the director's conduct in the particular case is to be measured, since reasonableness is a relative concept and can only be judged by reference to a standard: Opera House Investments Pty Ltd v. Devon Buildings Pty Ltd (1936) 55 CLR 110, at 117, per Starke J.; Friedrich at 122. The standard of conduct would, doubtless, have been that required of a competent director seeking to act reasonably in accordance with his or her duties under the Corporations Act and the general law: Kemish (supra); Friedrich at 124ff. In other words, the standard of conduct for a defence under subsection (4) would have been measured by the same test as is required for defences under subsections (2) and (3).
114 But subsection (4) eschews the test of reasonableness with its in-built standard of conduct by reference to the obligations of a director under the Corporations Act and the general law. It requires that a "good reason" for non-participation in management be shown. By what standard is "good" to be measured?
115 So far as I am aware there is only one case which has dealt with s.588H(4), a decision of Austin J. in Tourprint International Pty Ltd (In liq) v. Bott (1999) 32 ACSR 201. There the defendant, Mr Bott, had worked for the plaintiff company for some time before becoming a director at the invitation of another director, Mr Moore. Mr Moore told Mr Bott that the other co-director was about to resign and that another director would be needed because at least two directors were required for the company. Mr Bott accepted Mr Moore's invitation because he regarded Mr Moore as a friend in need of help. When a claim was brought against him under s.588M for insolvent trading, Mr Bott asserted that he had taken no part in the management of the company and had made no enquiries about its financial position because he had relied upon Mr Moore's misleading statements that the company was sound.
116 His Honour accepted that Mr Bott had been deceived by Mr Moore and that Mr Bott had taken no part in the "financial management" of the company. However, his Honour doubted that Mr Bott had not taken part in the management of the company at all. He had played an important part in sales and in debt recovery. It was also relevant to note that, prior to commencing to work for the plaintiff company, Mr Bott had been managing director of another company with an annual turnover of around $3.5M. In that capacity he had received financial reports on a monthly basis. He was not financially sophisticated but he was not financially naive.
117 In these circumstances, his Honour rejected Mr Bott's defence that he had a "good reason" for not participating in the management of the company. His Honour referred to the absence of authority directly in point as to the meaning of "good reason" and said at p.217:
"The provision seems to have its source in the Report of the General Insolvency Inquiry by the Australian Law Reform Commission (Report 45 - "Harmer Committee Report"), which said at para 312 that 'it is not appropriate for a provision designed to establish a proper standard of conduct by directors to impose liability on a director who was not in a position to influence the management of the financial affairs of the company at the relevant time'. Mr Bott says that he was not in a position to influence the management of the financial affairs of the company because Mr Moore deceptively excluded him.
In my opinion Mr Bott's submission is contrary to the policy underlying the subsection as disclosed by the Harmer Committee. In para 312 the Harmer Committee expressed the view that a director should not be excused where, though acting reasonably, he has not shown the 'necessary commitment to an involvement with the management of a company in financial difficulties'. Mr Bott clearly did not show a proper degree of commitment to involvement in the financial management of the company, for he was never involved in financial management at all. He ought to have realised that by not having any such involvement, he was not properly discharging his responsibilities as a director. He ought to have taken steps from the outset, and at least by mid-1993, to ensure that he had a proper degree of involvement as a director in the management of the company. He ought, in short, to have confronted Mr Moore and insisted upon proper involvement in the company's affairs. He cannot now treat Mr Moore's deceptive conduct as a good reason for not taking part in management when he did not assert his rights as a director from the outset and with vigour."