Directors’ duties | a timely reminder

In the New South Wales Supreme Court decision of Chung-Yi Pty Limited v Justin Chih-Yang Chang (No 2)¹, the Court held that a family company director breached his director’s duties by making payments from company funds amounting to over $5.4million, money directed to be repaid to the company.

Cheng Chung-Yi (Mr Cheng), a successful Taiwanese businessperson, established Chung-Yi Pty Limited (Chung-Yi) to hold his investments in Australia.

Chung-Yi bought six properties (Properties) funded from the combined capital of the company ($11,000,000), which was funded by loans made by Mr Cheng through various individuals who were resident overseas (Foreign Accounts), and other commercial borrowings. 

Mr Cheng had five children.  His eldest son Justin, at Mr Cheng’s direction, was responsible for managing the day-to-day operations of Chung-Yi, and was a director of the company.  During his lifetime, Mr Cheng gave directions to Justin in handwritten notes as to how any profit earned by Chung-Yi should be distributed amongst family members.  The siblings were all shareholders of Chung-Yi. 

On 11 July 2006, Chung-Yi sold two of its properties.  Although Mr Cheng subsequently consented to the sale of these properties, there was a dispute between the siblings about whether Mr Cheng consented to their sale before they had been completed.  After the sale the relationship between Justin and his siblings broke down.  Whilst the reasons for the break down were in dispute, the evidence showed that from about the time of the property sales that Justin’s siblings began to question the sales.  They started asking for information about the affairs of Chung-Yi.

Mr Cheng died in August 2012.  Justin arranged for financial information about Chung-Yi to be provided to his siblings in response to their request for it.  The material included a spreadsheet that purported to provide details of the payments made by Chung-Yi to each family member, together with copies of a number of Mr Cheng’s handwritten directions which were annotated by Justin. 

Justin’s siblings and their partners were dissatisfied with the provided information and issued proceedings in the Supreme Court of New South Wales.  There were eight plaintiffs, including Chung-Yi, the siblings and their partners (Plaintiffs).

The Plaintiffs brought two claims:

1. The first claim alleged that Justin made five payments to himself from Chung-Yi funds which were not authorised by either Chung-Yi or Mr Cheng and made in breach of his duties as a director arising from ss 180 – 182 of the Corporations Act 2001 (Cth) (Act) and in breach of his fiduciary duties, and that Chung-Yi is entitled to recover those payments, together with interest thereon, from Justin (First Claim).
2. The second claim alleged that Justin paid himself money from the Foreign Accounts which was either held in those accounts on trust for family members, or on a constructive trust in favour of Chung-Yi (Second Claim).

Justin brought a cross-claim seeking a declaration that the conduct of Chung-Yi in bringing the proceedings against him and not his siblings, and in raising security for the proceedings through a rights issue in Chung-Yi, was oppressive, unfairly prejudicial to, or unfairly discriminatory against, him, and consequential orders.  This article focusses on the main proceedings only.

First Claim: Payments not authorised by Chung-Yi or Mr Cheng

Chung-Yi claimed five amounts from Justin representing five payments that Justin had made to himself from Chung-Yi money.  These payments amounted to over $5 million and included an amount Justin paid to himself by way of dividend, withdrawals from the Chung-Yi account to purchase a house for his daughter, and amounts directly paid from a Chung-Yi account to Justin’s personal account. The plaintiffs alleged that these payments were not authorised by Chung-Yi or Mr Cheng, and, in making those payments, Justin breached the following duties under the Act:

1. To discharge his duties as a director with the degree of care and diligence that a reasonable person would exercise if they were a director of a corporation in the corporation’s circumstances and had the same responsibilities as Justin.²
2. To exercise his powers and discharge his duties in good faith in the best interests of the corporation and for a proper purpose.³
3. Not to improperly use his position to gain an advantage for himself or someone else or cause detriment to the corporation.⁴

The plaintiffs sought compensation for the payments made, in the form of an order under section 1317H(1) of the Act. The plaintiffs also submitted that Justin breached his fiduciary duties as a director and, in particular, his duty not to profit personally from his position as a director. The plaintiffs sought equitable compensation from Justin for this breach.

Justin relied on the following defences:

1. The payments should not be recovered because similar payments were made to the plaintiffs.
2. A limitation defence.
3. A defence of laches.⁵
4. Defences under s 180(2) of the Act – where a director makes a business judgment in good faith and for a proper purpose.
5. ss 1317S, 1318 and 1322(4) of the Act – gives the court the power in certain circumstances to relieve a person who has acted honestly from a liability in respect of a breach relevantly of ss 180 – 182.

During the proceedings, Justin was only able to give vague and general explanations of the payments by reference to his father’s wishes.  However, he sought to justify:

1. the first two payments by reference to what was said to be Mr Cheng’s expression that there be equality of treatment of siblings; and
2. the last three payments as the reimbursement of tax that he had paid in accordance with his father’s general direction that Chung-Yi should pay all taxes.

Justin gave evidence of various conversations in which he said his father made these directions.

The judge did not accept that Mr Cheng had given any instruction to Justin in relation to equalisation or tax. The evidence demonstrated that Mr Cheng’s general practice was to give instructions in relation to the division of assets or income on a case by case basis. Mr Cheng’s written notes did not contain general directions. 

Further, whilst Justin sought to rely on the spreadsheet to show that distributions had been equal, the spreadsheet was not clearly explained and the payments shown on the spreadsheet, in many cases, had no supporting evidence.

The last three payments could not be correlated to the relevant tax assessments. In fact, the tax assessments actually demonstrated that that the payments Justin made to himself were not payments in respect of tax.

The Court therefore held that the payments had not been authorised by Mr Cheng. Subject to the defences, Justin was liable for the five payments, and was found to have contravened his duties as a director outlined above.

The Court held that none of the defences relied on by Justin could be established for the following reasons:

1. Justin was not entitled to rely on the statutory limitation bar as he was guilty of fraudulent concealment, knowing that he did not have authority from his father to make the payments.
2. Justin was unsuccessful with the laches defence because the Court was not satisfied that he had suffered any prejudice because of the delay in bringing the proceedings, and held that the delay was justified.
3. Justin was unsuccessful in the statutory defences as the first was not a defence to the provision which Justin had most obviously breached, and the Court was not satisfied that Justin acted honestly to invoke the other provisions.

Second claim - Foreign Accounts

This claim related to a large number of payments that Justin made from some of the Foreign Accounts to himself, or in some cases to Lawrence, his son. The plaintiffs alleged that Chung-Yi was the source of the moneys in the Foreign Accounts that were paid to Justin and Lawrence, and that Justin was not authorised to pay those moneys to himself and/or Lawrence. The Court determined that Justin held the moneys on a remedial constructive trust for Chung-Yi or was liable to pay Chung-Yi equitable compensation equivalent to the amount that was misappropriated.

The Court acknowledged that the Second Claim was difficult to make out. The money in question was paid through intermediate accounts and it was not possible to trace the payments from accounts of Chung-Yi through the intermediate accounts to a Foreign Account because not all bank records were available. The Court separately analysed each of the payments claimed and concluded that only two of the payments could be recovered.  This was because there were only two payments that the Court was satisfied directly came from Chung-Yi funds.

Lavan comment

This case is an important reminder for directors to be acutely aware of their duties, both outlined in the Corporations Act and in equity, in carrying out their role.  They should be transparent and considered in their decision-making.  This is especially so where a family business is involved.  Directors of family owned companies should also be aware that their actions may be analysed and challenged by shareholders years after the transaction or conduct occurred.  The decision highlights the importance of keeping detailed records of why company distributions are made.

If you are a director and need assistance with decision making or a reminder of your duties or are a shareholder who is concerned about the conduct of a director or directors of a company you hold shares in, Lavan’s Corporate Disputes Team would be more than happy to assist.