One of the corollaries of the fact that companies are distinct legal persons is that shareholders and directors are not liable for debts of their companies, save in special circumstances.
One such example is the liability of directors under the Corporations Act for debts incurred by their company when it is insolvent.
However, a South Australian Full Court decision in Hanel v O’Neill on Section 197 of the Corporations Act seems to have overturned some basic precepts of company law, by holding that directors of trustee corporations are liable for their companies’ liabilities in circumstances where there is insufficient trust assets to meet the liabilities.
Section 197 (1) Corporations Act reads as follows:
A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or part of the liability if the corporation:
(a) has not, and cannot, discharge the liability or that part of it; and
(b) is not entitled to be fully indemnified against the liability out of trust assets.This is so even if the trust does not have enough assets to indemnify the trustee. The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection.’
The wording of Section 197(1) is somewhat unclear. The Court in Hanel concluded that the paragraph below sub-section 197(1)(b) has the effect that a director of a trustee corporation will be liable for debts of the company on any occasion when there are insufficient trust assets to meet the liability. The other construction, arguably a better one, is that the director is liable in such situations only where the trustee’s entitlement to an indemnity against trust assets is excluded.
As the South Australian Full Court’s decision is on a provision in national legislation, it is to be followed by all other courts save where such courts take the view that the decision is ‘plainly wrong’.
The decision in Hanel was recently upheld in Intagro v ANZ.
In that case, proceedings were brought by ANZ, on the basis that the two directors of a trustee company were personally liable under guarantees granted by the company.
The court in Intagro expressed reservations about the Hanel decision. However, it did not conclude that the decision was ‘plainly wrong’ and noted that as there was no obviously correct construction of section 197, the decision should be followed.
More recently, in Edwards v Attorney General, the New South Wales Court of Appeal had occasion to consider the correctness of the decision in Hanel. While the question of the proper construction of section 197(1) was not a key issue in that case, Young CJ was strongly critical of the majority decision in Hanel.
He noted the reservations expressed by the court in Intagro and the observations of McDougall J that the Hanel decision "could lead to the most extraordinary consequences".
Young CJ said that if the question of the proper construction of section 197 was before the court, he "may well have yielded to the temptation so valiantly resisted by McDougall J in the Intagro case".
The position remains somewhat uncertain as to whether Section 197 will be followed by other courts. This is a most unsatisfactory situation, given the prevalence of corporate trustees in the business community.
Trading trusts are used for many small businesses and many investment and financial services businesses are operated through corporate trustees.
It can only be hoped that an appeal court takes the opportunity to firmly reject the approach taken in Hanel v O’Neill, or that legislation is passed to amend section 197 so that its meaning is clear.
Tim Coyle, special counsel
9288 6761
Phillips Fox