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Diverting company opportunities – a firm warning for directors

19 March 2019
olivia christensen
Read Time 3 mins reading time

The fiduciary relationship between directors and companies has been tried and tested since the inception of the modern company. The law has made clear that directors are subject to an onerous set of obligations to act in the best interests of the company, even when external opportunities are presented to them personally.  Recently, the Courts have once again warned company directors against exploiting opportunities that should have been made available to their companies.

 Directors’ Obligations

Directors are subject to onerous statutory and fiduciary duties to the company including:

  • To act in good faith and in the best interests of the company and for a proper purpose (s.181(1) Corporations Act);
  • Not to improperly use their position to gain advantage or secret profits (s182);
  • Not to destroy or divert, without the consent of the company, an opportunity that may be pursued or considered by the company;
  • Not to misappropriate the company’s property or misuse company information for their own benefit or that of a third party (s183).
  • To notify other directors (in a directors meeting) of material personal interest in matters relating to company affairs (s.191)

Traditionally, the Courts have prevented directors from pursing opportunities that arose from their position.  Recently, the Court has expanded this obligation to include any opportunity obtained by virtue of their role and knowledge as a director, further tightening the restrictions on directors.

Recent warning by the Court

In CellOS Software Limited v Huber [2018] FCA 2069, former CEO and director (Mr Huber) was found to have abused his position by diverting an opportunity for the company to raise new funds.  Mr Huber had been tasked with the company’s capital raising but instead he secretly purchased 48 million shares (below market) then on-sold them to third parties (at a substantially higher price).

Those third parties would likely have been part of the prospective investor pool interested in purchasing new equity.  Instead Huber’s transactions netted him significant profit, which he then loaned back to CellOS and otherwise used for personal matters.

The Federal Court found that this amounted to misuse of position arising from the diversion of an opportunity that should rightfully have been available to CellOS.

The dangers of many hats

Not all scenarios are as obvious or blatant as the CellOS example.  Matters can become complicated when a director is also a shareholder, other stakeholder, or simply has a proliferation of business interests or an entrepreneurial flair that leads to over zealous or self-interested decision making.

Some examples (including those observed during the author’s career), that at a minimum, warrant further scrutiny (and due process) include:

  • Shareholders Agreements (SHA) with provisions permitting shareholders to start new business opportunities (externally) after first offering them to fellow shareholders – Throw into the mix that each (or most) shareholders are also on the board. It may well be the case that the “opportunity” is connected to knowledge gained as an employee or director. Irrespective of the “permissions” (implied or otherwise) in the SHA, a legal or fiduciary duty tied to either role, may prevent diversion of that opportunity – at least until it has been considered and rejected by the company.
  • Licensing out Company A’s property in order to escape a dysfunctional board and/or bickering shareholder base; especially if any of Company A’s directors are to be involved in the side venture.
  • Directors taking a “finders fee” in connection with funds that they introduce to their company – Depending on the directors’ position and role, and the “services” provided for the finders fee, such an arrangement may result in double-dipping and making a separate profit from the company in respect of matters that were already the domain of present roles. Other issues also arise (such as conflicts of interest).

No get out of jail free card

There are no easy avenues to side step these duties.  Courts have ruled that:

  • There is no need to demonstrate that an opportunity taken by the defendant was one that could have been exploited by the company: Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134.
  • Shareholder consent cannot excuse liability for a breach of the statutory duties: Angas Law Services Pty Ltd (in liq) v Carabela (2005) 226 507 but may be relevant in assessing whether the conduct was improper: Capricornia Credit Union v ASIC; ASIC v Maxwell.
  • The case of Adrenalin International Powersports Pty Ltd v John Caines Management Pty Ltd [2004] FCA 206 considered (amongst other things) whether directors and officers conspired to defraud shareholders and examined the manner in which shareholder consent was purported to be obtained. The case upheld that generally, it is insufficient to obtain such consent from the remaining disinterested directors and that it would need to be obtained by an ordinary resolution at a general meeting: see Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378 and Furs Limited v Tomkies (1936) 54 CLR 583.

 Navigating the Director Role

Directors need to be fully aware of the obligations that they owe to the company and how these may impact any external opportunity that arises.  A breach of directors’ duties can carry significant penalties, including the requirement to account to the company for any secret profits obtained.

If you need help assessing whether an opportunity should go to a company you serve, or whether it is fair game, our corporate law experts can help.

 This article was written by Olivia Christensen, Special Counsel, Commercial (Corporate).

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Diverting company opportunities – a firm warning for directors

19 March 2019
olivia christensen

The fiduciary relationship between directors and companies has been tried and tested since the inception of the modern company. The law has made clear that directors are subject to an onerous set of obligations to act in the best interests of the company, even when external opportunities are presented to them personally.  Recently, the Courts have once again warned company directors against exploiting opportunities that should have been made available to their companies.

 Directors’ Obligations

Directors are subject to onerous statutory and fiduciary duties to the company including:

  • To act in good faith and in the best interests of the company and for a proper purpose (s.181(1) Corporations Act);
  • Not to improperly use their position to gain advantage or secret profits (s182);
  • Not to destroy or divert, without the consent of the company, an opportunity that may be pursued or considered by the company;
  • Not to misappropriate the company’s property or misuse company information for their own benefit or that of a third party (s183).
  • To notify other directors (in a directors meeting) of material personal interest in matters relating to company affairs (s.191)

Traditionally, the Courts have prevented directors from pursing opportunities that arose from their position.  Recently, the Court has expanded this obligation to include any opportunity obtained by virtue of their role and knowledge as a director, further tightening the restrictions on directors.

Recent warning by the Court

In CellOS Software Limited v Huber [2018] FCA 2069, former CEO and director (Mr Huber) was found to have abused his position by diverting an opportunity for the company to raise new funds.  Mr Huber had been tasked with the company’s capital raising but instead he secretly purchased 48 million shares (below market) then on-sold them to third parties (at a substantially higher price).

Those third parties would likely have been part of the prospective investor pool interested in purchasing new equity.  Instead Huber’s transactions netted him significant profit, which he then loaned back to CellOS and otherwise used for personal matters.

The Federal Court found that this amounted to misuse of position arising from the diversion of an opportunity that should rightfully have been available to CellOS.

The dangers of many hats

Not all scenarios are as obvious or blatant as the CellOS example.  Matters can become complicated when a director is also a shareholder, other stakeholder, or simply has a proliferation of business interests or an entrepreneurial flair that leads to over zealous or self-interested decision making.

Some examples (including those observed during the author’s career), that at a minimum, warrant further scrutiny (and due process) include:

  • Shareholders Agreements (SHA) with provisions permitting shareholders to start new business opportunities (externally) after first offering them to fellow shareholders – Throw into the mix that each (or most) shareholders are also on the board. It may well be the case that the “opportunity” is connected to knowledge gained as an employee or director. Irrespective of the “permissions” (implied or otherwise) in the SHA, a legal or fiduciary duty tied to either role, may prevent diversion of that opportunity – at least until it has been considered and rejected by the company.
  • Licensing out Company A’s property in order to escape a dysfunctional board and/or bickering shareholder base; especially if any of Company A’s directors are to be involved in the side venture.
  • Directors taking a “finders fee” in connection with funds that they introduce to their company – Depending on the directors’ position and role, and the “services” provided for the finders fee, such an arrangement may result in double-dipping and making a separate profit from the company in respect of matters that were already the domain of present roles. Other issues also arise (such as conflicts of interest).

No get out of jail free card

There are no easy avenues to side step these duties.  Courts have ruled that:

  • There is no need to demonstrate that an opportunity taken by the defendant was one that could have been exploited by the company: Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134.
  • Shareholder consent cannot excuse liability for a breach of the statutory duties: Angas Law Services Pty Ltd (in liq) v Carabela (2005) 226 507 but may be relevant in assessing whether the conduct was improper: Capricornia Credit Union v ASIC; ASIC v Maxwell.
  • The case of Adrenalin International Powersports Pty Ltd v John Caines Management Pty Ltd [2004] FCA 206 considered (amongst other things) whether directors and officers conspired to defraud shareholders and examined the manner in which shareholder consent was purported to be obtained. The case upheld that generally, it is insufficient to obtain such consent from the remaining disinterested directors and that it would need to be obtained by an ordinary resolution at a general meeting: see Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378 and Furs Limited v Tomkies (1936) 54 CLR 583.

 Navigating the Director Role

Directors need to be fully aware of the obligations that they owe to the company and how these may impact any external opportunity that arises.  A breach of directors’ duties can carry significant penalties, including the requirement to account to the company for any secret profits obtained.

If you need help assessing whether an opportunity should go to a company you serve, or whether it is fair game, our corporate law experts can help.

 This article was written by Olivia Christensen, Special Counsel, Commercial (Corporate).