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Personal Liability Of Directors

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Questions:

1.Advise the various creditors as to their rights to recover their Debts.
 
2.Is the Company bound to perform its Obligations under this Contract.
 
 

Answers:

1.There are number of ways through which creditor can recover the payment of a debt from individual who refuses or cannot pay the debt. It is necessary that individuals must be aware of their rights and obligations related to the recovery of debt.

Section 197 of the Corporation Act 2001 deal with the personal liability of directors in discharging the liabilities incurred by trustee companies. There is famous case law in this regard Hanel v. O’Neill[1]. It was the first case which considers the scope and circumstances of director’s liability in pursue of this section. December 2003, South Australian Supreme Court state the various interpretations related to this section. The net result of this interpretation is that, number of directors of trustee companies faced uncertainty related to their potential personal liabilities.

The corporation Act 2001 imposes additional responsibility on the directors of the company which act as trustee of the company. Generally, trustees of the company have right to indemnity against the assets and property of the trust for the purpose of discharging companies liability which they incurred as trustee of the company. However, in case it is not possible to call the right of indemnity then Corporation Act impose this liability on the directors of the trustee company, for any unsatisfied liabilities which is incurred by company in its capacity as trustee. Therefore, Section 197 of the Act imposes potential liability on a director of the company when it incurs liability while acting as trustee of the company[2].

In other words, directors of the corporate trustee will be held personally liable only in case right of indemnity of company as trustee has been lost because of the unfair conduct on the part of the company or because of the restriction in the terms of the trust that purports to deny the right of indemnity.

 


Section 197 of Corporation Act 2001 states that directors of the company are liable for debts and other obligations which incurred by company as trustee, and as per this section if person is a director of the company when company incurs a liability while acting or purporting to act as trustee, then director is liable to discharge whole or a part of the liability if the company:

has not discharged or not able to discharged the liability or part of the liability, and

is not entitled to be fully indemnified against the liability out of trust assets because of the following reasons that is corporation breach the trust, corporation does not act within the scope of its powers as trustee, and any term of the trust limit or deny the right of company to be indemnified against the liability.

The liability of person is extent to both individually or jointly with the corporation and any other person also who is liable under this Subsection. It must be noted that person is not held liable under this subsection just because there are not sufficient assets out of which the corporation can be indemnified.

Person is not held liable under subsection (1), if such person would be entitled to have been fully indemnified by any other director against the liability imposed on all the directors of the company been trustees when the liability was incurred. This Section does not apply to a liability incurred outside Australia by a foreign company[3].

This section is not applied to a liability incurred by registered Australian body outside its place of origin, and it is not applied to a corporation that is an Aboriginal and Torres Strait Islander corporation[4].

In the present case, Michael and Claire smith are the shareholders and directors of Woodcraft Pty Ltd, and this company is the trustee of the Smith Family Trust. On behalf of the trust company runs the business of furniture. As per the trust deed, trustee is authorized to engage in wholesale and retail trade of furniture of all types, kind and nature.

Later, Michael and Claire decided to expand the business of the company, and the company order timber of the amount of $20000 from Forest Products Pty Ltd. They borrow $500,000 from Eastpac Bank Ltd from which they purchase the stud, and also borrowed $2,500,000 from National Finance Ltd and purchase a commercial property.

 


Business of the company fails and company becomes unable to pay its debt. Trust owned the assets worth $5000 and directors of the company have substantial assets. Eastpac received the trust deed from the company, before approving the loan of the company.

In this case Section 197 is applicable, and as per this section if person is a director of the company when company incurs a liability while acting or purporting to act as trustee, then director is liable to discharge whole or a part of the liability if the company has not discharged the liability or part of the liability, and is not entitled to be fully indemnified against the liability out of trust assets because of the following reasons that is corporation breach the trust, corporation does not act within the scope of its powers as trustee, and any term of the trust limit or deny the right of company to be indemnified against the liability[5].

In this case company is not able to discharge its liability and it is not possible to fully indemnify the liability against the trust because directors of the company do not act within the scope of powers.

Therefore, creditors can seek amount from the directors of the company, and directors of the company are personally liable for the debts of the company.

 


2.Generally, company enters into a contract through an agent with an outsider, and that agent act on behalf of the company. Common law established the indoor management rule in the case of Royal British Bank v. Turquand[6]. In this case, Court allowed the outsider to make the assumption that officer of the company complied with the rules of the company. In this case, directors give the guarantee to their bankers for borrowing the amount, and they did not complying with the requirement related to shareholders approval. Later, company avoids payment on the grounds of getting shareholder’s approval. In this Court rejected this ground and stated that bank has right to assume that directors of the company complied with the internal rules of the company and borrowings were duly authorized.

This decision is known as the "rule in Turquand's case" and latterly as the "Indoor Management Rule". This rule was approved by High Court in case Albert Gardens (Manly) Ltd v. Mercantile Credits Ltd, and High Court make it comments in the case of Northside Developments Pty Ltd v. Registrar-General. Later this case becomes an important consideration for the purpose of this rule because of the comments made in this rule[7][8].

Company made number of contracts while conducting their business operations and those persons who entered into contract on behalf of the company has power to bind the company by their actions. This power to bind the company is known as authority, and authority can be of three types actual, implied, and ostensible. In case, Hely-Hutchinson v Brayhead Ltd Judges[9] stated that directors of the company have the authority to bind the company, but in case directors of the company does not have authority than there is no contractual relationship between the parties. There are some situations when representative of the company including director who does not have authority to enter into a contract with third party, then in such situations there is no binding contract between the parties and the company because person does not have any authority. Court stated that person who is conducted business with the company must ensure that internal rules of the company are complied. Later, this rule was considered as inappropriate rule because person including directors who is representing the company is the well-known face of the company and third party has believe that person complied with the rules of the company and because of this consequences are faced by the third party. Therefore, for the purpose of solving this issue Court considered that if third party believes that all internal rules are compiled and representative has the authority to enter into contract then such contract is legally binding on parties[10].

 


There is exception to this rule that is Doctrine of constructive notice, actual knowledge, due inquiry, and forgery. If any exception is present then party cannot use the indoor management rule as defense.

In the present case, Tom is the company secretary of Midas Ltd, and as per the constitution of the company all contracts which are signed on behalf of the company must be approved by the board of directors of the company. Constitution further stated that once contract approved by the board then it must be signed by company secretary or one director of the company.

Tom convince jack (director of the company) to enter into a contract for the purpose of purchasing land for the company, and sign the contract with him for the purchase of the site of the company. Both Tom and Jack signed the contract, and later this contract was not approved by the board of directors of the company.  

In this case, there is binding contract because director and company secretary are authorized to act on behalf of the company and as per this rule if third party believes that all internal rules are compiled and representative has the authority to enter into contract then such contract is legally binding on parties. Therefore, there is binding contract on the company.

 

References

Paul james & paul Molnar, (2005), Personal liability of directors of corporate trustees, https://www.claytonutz.com/knowledge/2005/june/personal-liability-of-directors-of-corporate-trustees, Accessed on 5th August 2017.

Dino Travalgini, (2007). Corporate Recovery: Corporations Act – Section 197, https://www.mondaq.com/australia/x/54966/Corporate+Commercial+Law/Corporate+Recovery+Corporations+Act+Section+197, Accessed on 5th August 2017.

Lang thai, DIRECTORS’PERSONAL LIABILITY- IS THE PROPOSED AMENDMENT TO SECTION 197 ACCEPTABLE WHEN COMPARED WITH HANEL V O’NEILL?, https://www.google.co.in/url?sa=t&rct=j&q=&edata-src=s&source=web&cd=3&cad=rja&uact=8&ved=0ahUKEwiMsNG-p7_VAhXC6Y8KHTXaCywQFggvMAI&url=https%3A%2F%2Fojs.deakin.edu.au%2Findex.php%2Fdlr%2Farticle%2Fdownload%2F302%2F306&usg=AFQjCNERh3KdUWttCsF37QUOBMXCT2Te7w, Accessed on 5th august 2017.  

Lexology, The 'indoor management rule' explained, < https://www.lexology.com/library/detail.aspx?g=469212cf-f6d8-458d-8a5d-2722c5d4ba99>, Accessed on 5th August 2017.

Austlii, (2002), Protecting Outsiders to Corporate Contracts in Australia, < https://www.austlii.edu.au/au/journals/MurUEJL/2002/22.html>, Accessed on 5th August 2017.

David morrinson, The Continued Role of the Common Law Indoor Management Rule Due Inquiry Exception, < https://espace.library.uq.edu.au/data/UQ_356124/UQ356124_OA.pdf?Expires=1502004654&Signature=WCKFylx-o93psyc8EkLQ7akKpP8WPGdU8uGgkVyHZWYfq5QxNsfAAj~WR3qzs9QxWcTVkXfGe0KQEHsc7nOxkpLnfMXWySTxFTAfMQVpKybkR0gSyDs5QW1JhIVyxp370I76zhxJ3pClBbBOD0oCL4TB1YJU0dLJ9KftanMHtlwTYkZ1sWaNYVH1MBqHt83VIP8F6K5qnJBxASqfod1IZxrdoVg1YvXsA32D2KeTOjPyR5-9u7Lq8-2f2HPWtf-VrBqz8NLPAMpdZphngkfmS0UA-pt77qV9oXR0fgvdfpBs~QbdOqIcQ5q4lVjGcKgh-CyRAA6fJX1SPXz-8ytiCg__&Key-Pair-Id=APKAJKNBJ4MJBJNC6NLQ<, Accessed on 5th august 2017.

Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549.

Hanel v. O'Neill, (2003) 48 ACSR 378; (2004) 22 ACLC 274; (2003) SASC 409 (SC of SA 2003).

Royal British Bank v Turquand (1856) 119 ER 886.

Corporation Act

Hanel v. O'Neill, (2003) 48 ACSR 378; (2004) 22 ACLC 274; (2003) SASC 409 (SC of SA 2003).

Paul james & paul Molnar, (2005), Personal liability of directors of corporate trustees, https://www.claytonutz.com/knowledge/2005/june/personal-liability-of-directors-of-corporate-trustees, Accessed on 5th August 2017.

Corporation Act 2001- Section 197.

Dino Travalgini, (2007). Corporate Recovery: Corporations Act – Section 197, https://www.mondaq.com/australia/x/54966rporate+Commercial+Law/Corporate+Recovery+Corporations+Act+Section+197, Accessed on 5th August 2017.

Lang thai, DIRECTORS’PERSONAL LIABILITY- IS THE PROPOSED AMENDMENT TO SECTION 197 ACCEPTABLE WHEN COMPARED WITH HANEL V O’NEILL?, https://www.google.co.in/url?sa=t&rct=j&q=&edata-src=s&source=web&cd=3&cad=rja&uact=8&ved=0ahUKEwiMsNG-p7_VAhXC6Y8KHTXaCywQFggvMAI&url=https%3A%2F%2Fojs.deakin.edu.au%2Findex.php%2Fdlr%2Farticle%2Fdownload%2F302%2F306&usg=AFQjCNERh3KdUWttCsF37QUOBMXCT2Te7w, Accessed on 5th august 2017.

Royal British Bank v Turquand (1856) 119 ER 886.

 Lexology, The 'indoor management rule' explained, < https://www.lexology.com/library/detail.aspx?g=469212cf-f6d8-458d-8a5d-2722c5d4ba99>, Accessed on 5th August 2017.

Austlii, (2002), Protecting Outsiders to Corporate Contracts in Australia, < https://www.austlii.edu.au/au/journals/MurUEJL/2002/22.html>, Accessed on 5th August 2017.

Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549.

David morrinson, The Continued Role of the Common Law Indoor Management Rule Due Inquiry Exception, < https://espace.library.uq.edu.au/data/UQ_356124/UQ356124_OA.pdf?Expires=1502004654&Signature=WCKFylx-o93psyc8EkLQ7akKpP8WPGdU8uGgkVyHZWYfq5QxNsfAAj~WR3qzs9QxWcTVkXfGe0KQEHsc7nOxkpLnfMXWySTxFTAfMQVpKybkR0gSyDs5QW1JhIVyxp370I76zhxJ3pClBbBOD0oCL4TB1YJU0dLJ9KftanMHtlwTYkZ1sWaNYVH1MBqHt83VIP8F6K5qnJBxASqfod1IZxrdoVg1YvXsA32D2KeTOjPyR5-9u7Lq8-2f2HPWtf-VrBqz8NLPAMpdZphngkfmS0UA-pt77qV9oXR0fgvdfpBs~QbdOqIcQ5q4lVjGcKgh-CyRAA6fJX1SPXz-8ytiCg__&Key-Pair-Id=APKAJKNBJ4MJBJNC6NLQ<, Accessed on 5th august 2017.

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