Case Introduction
The brief facts of this case are that a funeral business was operated by the Kinsela family by incorporating a company. This company had taken insurance to cover the cost of funeral services, however after the introduction of a new law that was introduced with a view to regulate insurance services, the family was concerned that their business may be affected adversely as a result of its vicarious financial condition. Under these circumstances, the family company signed a lease with the husband and wife (who were the director and shareholder in the family company) to read the business premises of the company at a price that was begin play lower than its market value. This had taken place at a time when it had already became clear that the company had become insolvent. After the company was placed in liquidation, the transfer of the lease was challenged by the liquidator on the grounds that in this case, the directors of the company had breached their fiduciary duty as the directors did not mull over the creditors’ interests when they had transferred the least of themselves at a value less than its market value. While deciding the case, the court arrived at the conclusion that in this case, there has been a breach of duty. As the shareholders of the company, the directors cannot be allowed to approve their own conduct as a result of the detriment that has been caused to the creditors due to such conduct. Due to the reason that the directors were aware of the fact that the company was approaching insolvency, the assets of the company are in a particular way, the assets of the creditors and not that of the shareholders, that are under the administration of directors through the medium of the corporation. The importance of this decision can be attributed to two reasons. First of all, it has been recognized in this decision that if the company is facing insolvency, the main beneficiaries of the duties imposed on the deck does change from the shareholders of the company to the creditors of the company as a whole. The second reason behind the significance of this decision is that reveals that the fiduciary duty of the directors, which requires them to consider creditors’ interests during the insolvency of the corporation cannot be relaxed or taken away by the shareholders.
The decision given in this case by the NSW Court of Appeal has provided the strongest judicial recognition to the fiduciary duties that the directors of a corporation owe provides its creditors. The court stated that when the corporation stands in the position of marginal solvency, the duty of the directors is towards the corporation as a whole not only covers the interests of the shareholders of the company that at the same time, the interests of the creditors of the company also covered by it. Therefore, when it can be said that there has been a breach of this fiduciary duty, to the detriment of the creditors of the corporation, it is not within the power or the authority of the shareholders of the company to resolve the directors from the breach. For example in the present case, Kinsela family members were the directors and shareholders in a number of corporations owned by the family and carried the trade as funeral directors. All of these corporations were well-known, and the family members were proud of their reputation of their companies. However, one of these companies, Russell Kinsela Pty Ltd also provided, apart from the funeral services, a form of contributory insurance against the cost of the funerals of its clients. Therefore the contributors made regular payments of small amounts, and in return, the company promised to provide cost free funerals. However, this game was not structured properly by the company as the company had failed to keep in mind the rising costs. The result was that by 1976, the company was facing irregular and increasing trading losses and at the same time, the liabilities of the company significantly exceeded the assets of the company. At the same time, this was the period when the Funeral Funds Act was brought into force. There were provisions present in this legislation, which required the companies which were carrying on funeral insurance schemes to disclose their financial position. Powers were granted by this legislation to a legal officer who could interfere in a defaulting company for protecting the creditors’ interests.
Outline the duties/responsibilities breached
Under the circumstances, Mr. Kinsela, who was an appellant and a director, came up with a proposal to which he expected that the family business may be able to continue although the collapse of the company had become quite evident. Therefore, a lease of the company premises was exhibited by the directors. This lease was for three years, and an option was available for the next three years. Mr. and Mrs. Kinsela had been mentioned as the lessees. There were particularly favorable terms mentioned entities however, it was collectively favoured by the shareholders of the company. In the same year, proceedings were starting to have the company wound up. Therefore the lease was challenged by the liquidator on the grounds by the court found it necessary to discuss only one ground in detail. It was argued by the liquidator that the power of the company to lease the premises have been used for a purpose that cannot be considered as being in the best interests of the shareholders. Therefore the liquidator claimed that this lease was voidable for the corporation. Conversely, it was argued by the appellants that the submission made by the liquidator could not be correctly due to the reason that the execution of lease was an act of the corporation, which was unanimously approved by all its shareholders.
It was held by Powell J. At first instances that although power is present with the directors of the company to lease the premises under the Articles of the company, however the power has not been used for the furtherance of the stated objects of the company. As a result, it was held that the lease was voided that the option of the company. Although his Honour at the reservations regarding the correctness of this principle, however there was a binding earlier decision of the NSW Court of Appeal that was delivered in Winthrop Investments Ltd. v Winns Ltd. (1975) according to which the consequences of the breach of duty by directors can be overcome if during the general meeting of the company, where all relevant disclosures have been made, including the fact of potential or actual breach, the breach has been ratified. But the court noted that in this case there was a lack of informed consent as as a result, it cannot be said that ratification has taken place. An appeal was made to the NSW Court of Appeal, which did not find it compulsory to determine if full disclosure was made or not because the Court arrived at the conclusion that the breach was of the nature that company did not have the power to ratify this breach in the general meeting of the company.
Critical Analysis of the Decision
While delivering its decision in this case, the court are referred to several previous decisions, which included the decision given in Mills v Mills for the purpose of affirming the principle according to which, the directors have a fiduciary duty which requires them to use their authority for the benefit of the corporation (Baxt, 2002). However, in case of insolvency, the court stated that this duty not only includes the duty to act for the benefit of the shareholders, but it also requires the directors to act for the benefit of the creditors also. Similarly, the decision given in Walker v Wimborne was also mentioned in this case. The court stated that it needs to be emphasized that while discharging their duties towards the company, the directors are required to consider the interests of the shareholders as well as the interests of the creditors of the company (Keay, 2001). On the other hand, if the directors failed to consider the interests of the creditors, it will have adverse consequences for the company and also for the directors. The duty that is owed by the directors towards the company may require them to consider the interests of the creditors. For example, the creditors are allowed under the law to be considered if the company is nearing insolvency or has become insolvent or if a payment order their course of action may result in jeopardizing the solvency of the company. Even though, Street CJ declined to formulate a general test that can be used to decide the level of monetary instability when a duty will be obligatory on the directors to keep in mind the interests of the creditors but he mentioned that such a duty will be present if the corporation is insolvent in as much as it is the funds of the creditors that is at risk, instead of being the proprietary interest of the shareholders. It was noted that to some degree, the level of financial instability and the risk faced by the creditors are interrelated (Redmond, 2012).
Under these circumstances, it was concluded by the court that although the lease was not ultra vires and void as beyond the capability of the company, the directors have created this lease by breaching their duty towards the corporation and to the detriment of the creditors of the company when the company was facing insolvency. And as a result, this lease cannot be affirmed by the shareholders of the company (Rosenberg, 2009). The result was that the transaction was considered as voidable by the company and therefore the company was allowed by the court to avoid this transaction.
In this regard, there are certain legal experts who have noted that the directors should keep in mind the creditors’ interests while discharging their fiduciary duty, in this case, an authoritative statement was made by the court for the first time regarding the existence and the scope of the duty that the directors owe towards the creditors of the company. The findings of the court, according to which there are certain circumstances when the duty of the directors towards the company can be considered to extend beyond the interests of shareholders (Veasey, 1985).
It is way, the reasoning of the court was that if the directors of the company have acted for promoting their personal interests or to support the personal interests of other persons, it can be said that the directors have not acted in the best interests of the company. In case of a solvent company, the interests of shareholders allow them to be considered as the corporation in context of the duties of the directors. If the shareholders, as a general body, have authorized or ratified an act of the directors, it not allowed by the law to challenge the validity of such an action of the directors (Sealy, 1988). On the other hand, if the company is insolvent, there is an intrusion by the creditors’ interests. The result is that the creditors are prospectively permitted through the mechanism of liquidation to relocate the power of the shareholders and directors to manage the assets of the corporation. In a practical sense, these are the assets of the creditors and not the assets of the shareholders that are under the management of the directors, through the medium of company, awaiting liquidation or return to solvency or until alternative administration.
References
Andrew Keay, (2001) ‘The Director’s Duty to Take into Account the Interests of Creditors: When is it Triggered?’ 25 Melbourne University Law Review 315
David Rosenberg, (2009) ‘Supplying the Adverb; The Future of Corporate Risk-Taking and the Business Judgment Rule’ 6 Berkeley Business Law Journal 217
Len Sealy (1988) ‘Directors Duties —An Unnecessary Gloss’ 47 Cambridge Law Journal 175
Norman Veasey, (1985) ‘Further Reflections on Court Review of Judgments of Directors: Is the Judicial Process Under Control’ 40 The Business Lawyer 1373
Paul Redmond, (2012) ‘Directors’ Duties and Corporate Social Responsiveness’ 35University of New South Wales Law Journal 317
Robert Baxt, (2002) “Just to Whom do Directors Owe their Duties? Will This Conundrum Ever be Satisfactorily Resolved?’ 30 Australian Business Law Review 455
Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722
Winthrop Investments Ltd v Winns Ltd (1975) NSW
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