In the recent case of DSHE Holdings Ltd (Receivers and Managers) (in liq) v Potts; HSBC Bank Ltd v Abboud; Potts v National Australia Bank Ltd  NSWCA 165, the New South Wales Court of Appeal considered the question of whether a director can breach their duties by approving the payment of dividends to shareholders during a time of financial strife, and the related question of the actual and potential extent of the director’s liability.
The matter revolved around two dividend payments made by DSHE Holdings Ltd (Receivers and Managers) (in liq) (DSH) in 2015 prior to DSH being placed into voluntary administration in January 2016. The receivers of DSH caused DSH to commence proceedings against the directors of DSH on the basis that the directors had breached their duties under section 180 of the Corporations Act 2001 (Cth) (Act) by voting in favour of those dividend payments having regard to the financial position of DSH at the time.
The claim was dismissed at first instance, and the receivers caused DSH to appeal. In determining the appeal, the NSW Court of Appeal was required to consider whether the payment of the dividends had prejudiced DSH’s ability to pay its creditors, and whether a failure to adequately consider this issue constituted a breach of the duties in section 180 of the Act.
Prior to its collapse, DSH, which traded under the name “Dick Smith”, had adopted a growth strategy which involved buying excess stock to maximise rebates from its suppliers. As part of this strategy, DSH entered into various facilities to fund the purchases of stock, and also engaged in a habitual practice of pushing out creditor payments as a way of managing its working capital position.
However, in the course of 2015, DSH began to run into financial difficulties. It entered into a syndicated working capital facility agreement with NAB and HSBC in June 2015 for the purposes of supporting its working capital position, but breached that agreement by drawing over $10m under the facility to pay another of DSH’s lenders, Macquarie Bank, in December 2015.
NAB wrote to DSH on 31 December 2015 to give formal notice of the breach, and the board of DSH subsequently resolved to place DSH into voluntary administration on 4 January 2016 with the banks appointing receivers shortly thereafter.
Following their appointment, the receivers turned their attention to two dividend payments made by DSH in 2015, being:
The receivers then caused DSH to commence proceedings against the directors of DSH on the basis that the directors had breached their statutory duties by voting in favour of these dividends.
It is uncontroversial that section 180 of the Act requires directors to exercise their powers and discharge their duties with care and diligence.
However, the section of concern from the perspective of the receivers was section 254T of the Act which provides that:
Circumstances in which a dividend may be paid
(1) A company must not pay a dividend unless:
(a) the company's assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend; and
(b) the payment of the dividend is fair and reasonable to the company's shareholders as a whole; and
(c) the payment of the dividend does not materially prejudice the company's ability to pay its creditors.
The receivers considered that the payment of the Interim and Final Dividends had materially prejudiced DSH’s ability to pay its creditors, and that the directors had failed to act with care and diligence by voting in favour of dividend payments that contravened section 254T.
The receivers also considered that DSH had suffered loss for the purposes of section 1317H of the Act in the amount of the dividends paid, and that the directors should be ordered to repay those amounts to the company.
As the appeal was brought only with respect to the claims against two of DSH’s directors, being Mr Nicholas Abboud who was the CEO and MD of DSH and Mr Michael Potts who was the CFO and a director of DSH, it is convenient to frame the first instance decision by reference to the findings against Mr Abboud and Mr Potts.
The matter was heard before Justice Ball who, after a 57 day trial, found that:
All of these findings were challenged in the appeal.
The NSW Court of Appeal (comprising Leeming and Kirk JJA, and Basten AJA) (Court of Appeal) effectively broke the appeal down into the following components:
Interaction between sections 180 and 254T of the Act
The Court of Appeal was satisfied that a director can breach their duties under section 180 to act with due care and diligence by voting on a dividend that is or would likely be in contravention of section 254T.
In considering the wording of section 254T, the Court of Appeal held that the section should be understood to mean that a dividend should not be paid if doing so would materially prejudice the company’s ability to pay its creditors as and when the debts to those creditors fell due, and that not to read these words in to the section would not be consistent with the purpose of the section and would lead to the strange outcome that section 254T could be satisfied merely by a liquidator ultimately being able to make a distribution paying creditors in full.
However, the Court of Appeal was careful to emphasise that when a dividend payment might cause such material prejudice was “fact intensive” and was something that would have to be assessed on a case by case basis. For example, the Court of Appeal noted that just because a company was paying its creditors late would not necessarily always mean that a dividend payment was in breach of section 254T. The Court of Appeal also considered the point raised in the appeal as to whether the availability of trading stock which could be sold would avoid any material prejudice arising, and said that no hard and fast rule could be applied and that the question would be whether the availability of such stock in fact meant that they could be sold and the proceeds used to pay creditor claims as and when they fell due.
Ultimately, the Court of Appeal was also satisfied that even though section 254T was not a civil penalty provision, linking the duties in section 180 to due consideration of a potential breach of section 254T was not a ‘back door’ way of imposing civil liability contrary to the intention of the Act, and that a breach of section 180 would occur if a director in the circumstances of the case exercising reasonable care and diligence would not have supported a resolution to pay a dividend due to an actual or potential breach of section 254T.
Breach in relation to Final Dividend
The Court of Appeal was satisfied that there had been a breach of duty in relation to the Final Dividend.
For Mr Potts, this was because he had actual knowledge of DSH’s daily and weekly cashflows which showed a cash shortfall or around $31m at the time the Final Dividend was to be paid. In the circumstances, it was simply not open for Mr Potts to say that a reasonable director in those circumstances would have voted in favour of the Final Dividend.
As to Mr Abboud, Mr Abboud had argued at trial that he had not known the detail of DSH’s cashflows and had thought that it was possible to create a plan to pay the creditors by pushing out their payment dates and realising stock. However, the Court of Appeal rejected this argument and found that Mr Abboud had breached his duties because he had failed to ask Mr Potts for more detailed information about the cashflow position, had failed to undertake any investigations or to develop any actual plan about whether the company’s stock could have been realised to pay creditors, and overall had failed to adequately consider whether the Final Dividend would be in breach of section 254T.
No breach in relation to Interim Dividend
As to the Interim Dividend, the Court of Appeal was satisfied that there had not been any breach of duty in relation to this dividend as the cashflow presented to the board at the meeting where the Interim Dividend was approved showed that DSH was within its working capital facility limits and would remain so at the time the Interim Dividend was paid (and indeed for the rest of the financial year).
The Court of Appeal conducted a detailed analysis of the meaning of damage for the purposes of section 1317H of the Act and the interaction between that section and sections 180 and 254T.
While it is not possible to do justice to that analysis in this article, the key points can be summarised as follows:
The Court of Appeal ordered that Mr Abboud and Mr Potts were liable to repay the amount of the Final Dividend, being $11.8m, to DSH.
This case is an important reminder of the scope of the duties owed by directors under section 180 of the Act, and that particular care must be taken in relation to any decisions to pay dividends to shareholders in circumstances where the company is in financial difficulty and the payment might materially prejudice the company’s ability to pay its debts as and when they fall due.
If you have any questions about this case, directors’ duties under section 180 of the Act, or the specific rules about dividends in section 254T of the Act, the experienced Lavan team is ready to help.