Shareholders (members) of private companies continually experience angst over their investments. There is always the greater element of risk when investing in a private and/or start-up company. More frequently after about six to twelve months they will find themselves bolt up-right in bed at 3am suddenly realising that they might not see their money ever again.
The person they have linked their financial fate with is the director (and self-appointed CEO) who promised if they brought the capital he would bring the ideas and execution. Around the time the first set of accounts are prepared it becomes obvious that he has used most of the money for ‘business development’ activities like lunches with friends and travel.
The avenues that are available to the member depend on the character of the director’s activities. That is, are the actions fraudulent, negligent, intentionally misleading or just bad business. The legal remedies available to shareholders will be a combination of the:
- constitution of the company (or Replaceable Rules if no constitution);
- shareholder’s agreement, if any;
- Corporations Act 2001 (Cth) (“Corporations Act”); and
- common law
Finding Out What Went On
The initial challenge is always finding out exactly what the director has been doing and what kind of transactions the company has been engaging in. While directors have usually complete and unfettered access to the records of the company automatically, members need to request access.
In most cases the constitution or a shareholder’s agreement will provide for shareholders having access to inspect records. However, if that is not the case, of if the director is resisting giving them access s247A Corporations Act provides scope for members to make application to the Court for an inspection of the company records.
The application must be made in good faith and for a proper purpose. The situation where access is requested because the member is considering litigation against the company or the director raises the question of whether it is in good faith or not and depending on the circumstances the application can still be granted.
In the event that the records are not properly maintained, have been destroyed or the member feels that an independent expert is required then s241 Corporations Act allows the Court to order a director to do, or not do any act; and also to appoint an independent person to investigate the financial affairs of the company.
Having satisfied themselves that the actions of the director are in breach of any of the obligations referred to above, the member can then take action in order to attempt to recover the investment and/or prosecute the director for the breaches.
Sections 180 to 184 Corporations Act contain the general duties that a director owes to the company. Sections 180 to 183 are civil liability provisions, meaning that criminal liability is not attached for a breach of these provisions only. Section 184 attracts criminal liability. The duties are to:
exercise care and skill (s180) – requiring the director to discharge their duties with the requisite degree of care and skill;
act in good faith (s181) – that is to act in good faith in the best interests of the company and for a proper purpose;
not misuse their position (s182) – meaning that the director cannot misuse the position they are in to obtain a benefit for themselves or someone else at the expense of the company;
not misuse company information (s183) – meaning that the director cannot misuse company information to obtain a benefit for themselves or someone else at the expense of the company; and
act in good faith and not misuse position or information – criminal liability (s184) – recasts the obligations of ss181 to 183 with a deliberate intention on the part of the director to attract criminal liability.
None of these provisions prevent a director being sued for negligence, breach of fiduciary duty or contract as the act specifically states that the obligations are in addition to and not in derogation of any other duty or liability that the director has at law.
These duties and their common law counterparts were discussed at length by the NSW Supreme Court in Macdonald
More often than not, attempts to get the investment returned are pointless because the money is long gone. Occasionally, however the director may have sufficient assets to satisfy a judgment and it becomes worthwhile for the member to take such action.
Where there is a shareholder’s agreement, a breach of fiduciary duty or negligence a personal action can be taken against the director. If that course of action is uncertain, the member might consider some form of external administration such as provisional liquidation, liquidation or receivership.
These types of actions will depend on the nature of the transactions and the existence of any agreements. However, State Courts are empowered to appoint receivers on the applicant demonstrating sufficient grounds. Similarly, a provisional liquidator can be appointed or the Court can order the winding up of the company for any of the grounds listed in s461 Corporations Act, which includes when directors are acting in their own interests.
Consequently, there are several avenues open to members that wish to pursue a rogue director. Their availability will ultimately depend on the relationships between the parties and the particular conduct of the director. The return of invested funds is never certain; however, it is achievable when the correct circumstances exist.