Directors’ duties and corporate transactions | Boros v Pages Property Investment [2021] NSWCA 288

This case, recently decided in the NSW Court of Appeal, looked at directors’ duties and potential conflicts of interest that may arise when a director holds office and shares in selected companies within a group.  Takeaway messages are:

1. the Court assesses a director’s duties contextually, with regard to the effects of directors’ decisions on the whole group;
2. any conflict of interest must be more than theoretical;
3. as always, diligent record keeping is critical.

Overview

The NSW Court of Appeal recently largely upheld an appeal by the director of a company, Mr Boros.  Mr Boros appealed against initial findings that he had breached his directors’ duties.  Mr Boros at one time was a director of two of the companies in the group but a shareholder in one of those companies.  Did Mr Boros have a conflict of duty and interest in his dealings between the two companies?  Did he breach his duties to the company in which he had no shareholding?

The Court of Appeal took a contextual approach, that relied very much on the facts of the case.  Emergent themes are that the Court will consider the interests of the group rather than a particular company, and that any conflict of interest must be real and substantial, not merely theoretical.  Finally, while the Court may exercise some latitude in its assessment of how directors exercise their duties of care and diligence,[1] the duty to keep true and fair financial records must be assiduously observed.

Context and background

“Pages Hire” was an event equipment hire business, which was run through a number of corporate entities, primarily for the benefit of the Page Family Trust.  One of these companies was Page Enterprise Hire (PEH).  PEH owned and leased equipment and other assets to other companies in the group.  Another group entity was Pages Property Investment (PPI), which was the corporate trustee of the Page Family Trust.  It owned the premises from which the business operated, which it leased to PEH.

Mr Page was the sole director of and sole shareholder in PPI, until his death in 2003.

Initially PEH was registered under the sole directorship of Mr Page.  In 1999, he appointed Mr Boros and Mr Thatcher, long-standing employees in the business, to the board.  The three PEH directors, Mr Page, Mr Boros and Mr Thatcher, effectively held 50% (held by PPI), 25% and 25% of the PEH shareholdings respectively, each through a family corporate structure.

Following Mr Page’s death in 2003, Mrs Page (his widow) became the sole director and 100% shareholder of PPI.  In 2008 Mrs Page resigned from the directorship of PPI and appointed Mr Boros as the sole director.  In 2016, following a period of financial difficulty for the business, Mrs Page exercised her majority shareholder power to remove Mr Boros from the directorship of PPI and appointed her son in his place.  Under the son’s directorship, PPI commenced proceedings against Mr Boros for breach of his director duties to PPI.  Mr Boros throughout this period remained a director of PEH.

Not all claims by PPI against Mr Boros succeeded.[2]  However at trial Mr Boros was found to have breached his duties to PPI on three issues:

1. underpaying the lease rental owing by PEH to PPI;
2. increasing PPI’s bank loan facilities, to pay down PEH’s debt;
3. failing to ensure PPI kept proper financial records.

Mr Boros appealed against these findings, predominantly successfully.

1. Was it a breach of duty not to undertake an annual rent review?

The initial lease contract between PEH and PPI contained a provision for an annual rental review, including a formula for calculating the review.  However PEH had paid the same monthly rental since the inception of the agreement, and did not undertake any rental reviews.

At trial, Mr Boros’s failure to undertake an annual rent review was found to breach his statutory duties, because he had failed to exercise powers and discharge duties with the degree of care and diligence of a reasonable person in his position.[3]  However, at appeal this was overturned, for the following reasons:

1. The drafting of the rental review provision was ambiguous. It was not clear whether the rent review mechanism operated automatically or a review must be undertaken, nor who was responsible for organizing and implementing a review.  The Court noted it was not a breach of duty not to seek legal advice in the interpretation of the clause, nor was it a breach not to undertake an annual rent review.
2. When Mr Boros became director of PPI, the lease contract had already been in operation for three years under Mrs Page’s directorship, without any rental review. Hence Mr Boros was following existing procedure.  (The Court observed that if Mr Boros had breached director duties, so had Mrs Page.)
3. When the lease contract expired 15 months after Mr Boros became director of PPI, the lease was not renewed but continued for a further 7 years with PEH holding over. It was not unreasonable for Mr Boros to believe that the rent-review provision did not operate in that holding over period.
4. The potential underpayment of rent by PEH to PPI benefitted PPI in its capacity as the 50% shareholder of PEH, and a reasonable person acting as director of PPI would realise that fact.
5. PEH made ‘top-up’ payments to PPI over the years. Although poorly accounted for, these were flexible (temporally and for tax purposes) payments that well exceeded any unpaid rental.
6. PPI had two sources of income: rental income from PEH and its shareholdings in corporate entities in the group. So long as the rent was at an adequate commercial rate, a low rental rate may have indirectly benefitted PPI in allowing PEH more flexibility to provide money when the business was not flourishing.

2. Was it a breach of fiduciary duty to increase PPI’s loan facility to pay down PEH’s debts?

The land owned by PPI was the business’s major asset.  PPI extended its loan facility, secured by the mortgage on that property, to reduce PEH’s debt.[4]

Was it a breach of fiduciary duty to increase the indebtedness of PPI (in which Mr Boros had no shareholding), and reduce the indebtedness of PEH (in which Mr Boros’ family company had a 25% shareholding)?  At first instance, this was considered a breach of fiduciary duty, but this decision also was overturned on appeal.

At appeal, the Court noted that the conflict of duty to company with the personal interest of the director must be real, not merely theoretical.  In this case:

1. The group benefited by reducing outgoings, and the director was entitled to consider the common interests of PPI and PEH in making his decisions.
2. No evidence established any actual direct or indirect personal financial benefit to Mr Boros.
3. PPI owned the major security in a cross-collateralised facility and would receive income from the business operations via its shareholdings in those corporate entities.
4. PPI’s incurred debt was balanced by its increased income as the 50% shareholder of PEH and the reduction of PEH’s debt.

3. Record keeping

It is a statutory duty under the Corporations Act to maintain fair and true financial records.[5]  The finding at trial that the company records were insufficient was not challenged on appeal.  The issue was who should bear the costs of reconstructing the records.  The Court of Appeal found that the costs order for reconstruction of the accounts should be set aside to the extent that it related to Mr Boros.

Conclusions

Alleged breaches of directors’ duties are assessed on a case-by-case basis.  In this case, the Court accepted that Mr Boros acted in the interests of the group, not just in the interests of the company of which he was the director and a shareholder.

Much of this expensive, time-consuming and stressful litigation may have been avoided if:

1. The financial records were maintained diligently; and
2. The lease contract was drafted without ambiguity in its rent review clause; and
3. The duties set out in the lease contract had been attended to.

A well-constructed contract sets out the parties’ intentions unambiguously and includes default mechanisms.  It is worth spending the time in discussion with experienced legal advisers prior to setting up or restructuring a business, particularly where there are related party transactions such as this case.  Even when businesses start out with good intentions and relations, subsequent disagreements can easily arise.  Good legal drafting at the outset facilitates their resolution with minimal expense of time and money.

[1] Section 180(1) Corporations Act.

[2] At trial the Court did not find Mr Boros had failed to act in good faith in the best interests of the corporation (s 181 Corporations Act); nor had he acted improperly to gain an advantage for himself or someone else (s 182 Corporations Act).

[3] S 180 Corporations Act.

[4] PPI’s indebtedness increased from $3.86 million to $5.565 million.

[5] S 286 Corporations Act.