Hawkins v Bank of China

(1992) 26 NSWLR 562

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(Judgment by: Kirby P) Court:

Judges: Gleeson CJ

Kirby PSheller JA

Subject References:
Companies
Directors and officers
Personal liability
For "debts incurred"
Company executing guarantee
Contingent liability for liquidated amount
Whether debt incurred
Winding up
Conduct and incidents of liquidation
Liability of officers for misfeasance
Liability for "debts incurred"
Company executing guarantee
Contingent liability for liquidated amount
Whether debt incurred
Guarantee and Indemnity
Guarantee
Construction and effect
Nature of obligation
Whether to pay unliquidated damages or liquidated debt
When "debt incurred"

Legislative References:
Companies (New South Wales) Code - s 556(1)(a); s 556(1)

Hearing date: 5, 6 March, 1 May 1992
Judgment date: 1 May 1992

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Judgment by:
Kirby P

KIRBY P . This appeal from Rogers CJ Comm D raises a point of importance concerning the personal liability of directors of a corporation for debts incurred by the corporation which later becomes insolvent. The appeal concerns the meaning of the phrase "incurs a debt" in s 556(1)(a) of the Companies (New South Wales) Code . That Code has now been replaced by theCorporations Law . However, the issue before the Court remains a live one, both because of the remaining cases (such as this one) which fall to be determined under the provisions of the Code and because the Corporations Law has re-enacted the provision: see ibid s 592(1)(a).

The facts and issues:

The facts are set out in the reasons of Gleeson CJ. His Honour also sets out the relevant statutory provisions and I will not repeat them. The separate question which Rogers CJ Comm D isolated was whether, by entering into a guarantee and indemnity between itself and Bank of China, Equiticorp International plc (Equiticorp) incurred a debt within the meaning of s 556(1) of the Code in such circumstances as to render the officers sued personally responsible for the debt so incurred. In terms, the question posed by Rogers CJ Comm D merely asked whether, by entering into the guarantee and indemnity, Equiticorp "incurred a debt" within the meaning of s 556(1)(a) of the Code. However, the answer to that question is critical for the liability of the officers of Equiticorp as they will escape any risk of personal liability if the action of the corporation of which they were officers, does not amount to "incurring" a "debt" within the meaning of s 556.

Rogers CJ Comm D answered the separated question in the affirmative. The appellants, who were the officers concerned, sought leave to appeal to this Court. Leave was readily granted as the issue involved is obviously one of general importance. It is also one of difficulty.

Two points were argued in the appeal. First, the officers contended that when a company executes a guarantee it is not "incurring" a "debt" within s 556(1)(a) of the Code in any case. Secondly, and alternatively, they argued that, at least in the terms of the particular guarantee executed in this case, the company did not "incur a debt" but only a contingent liability to pay damages.

Conflicting decisions at first instance:

Especially in circumstances of economic difficulty such as prevail at present, the acceptance of obligations by companies under agreements for guarantee of the debts of other (often related) companies and individuals is such a regular phenomenon that it would be surprising indeed if such conduct fell outside the operation of s 556(1)(a) of the Code. This would be especially surprising given the obvious purposes of s 556 and the legislative history of its progenitors. However, there have already been decisions on the section which have caused surprise, one of them being Metal Manufacturers Pty Ltd v Lewis (1988) 13 NSWLR 315 in this Court: see, eg, Robert Baxt, "Sleeping Directors Get a Second Chance" (1992) 20 ABLR 78 at 80. Accordingly, the only safe course to adopt in the controversy before the Court is to approach the task of construction of the words in the section in the orthodox way, giving effect to its purpose as expressed in those words.

No decision binds this Court to a particular construction. However, a number of decisions at first instance afford assistance. One, at least, has reached a conclusion favourable to the appellants. Others, including the decision of Rogers CJ Comm D, under appeal are adverse to their arguments. It is obviously highly desirable that the Code, and the equivalent provisions of the Corporations Law , should have a uniform interpretation throughout Australia. The principal purpose of the development of a national approach to company law in Australia has been to recognise the vital importance of corporations to the economic well-being of the whole country; the typical organisation of many corporations today on a national basis; and the inefficiency and uncertainty caused by differing constructions of the same law in different parts of Australia.

In accordance with its settled procedure, the Court's Registrar gave notice to the Australian Securities Commission, as the successor to the National Companies and Securities Commission which enjoys a right to intervene under the Code: cf Corumo Holdings Pty Ltd v C Itoh Ltd and BNY Australia Pty Ltd v C Itoh Ltd (1991) 24 NSWLR 370. The Commission appeared, put submissions and provided material. It supported the construction of the words in question adopted by Rogers CJ Comm D.

However, contrary opinions have been expressed in two earlier decisions in other States. In Russell Halpern Nominees Pty Ltd v Martin [1987] WAR 150, certain observations of Burt CJ (at 153) with the concurrence of Smith J are unfavourable to the conclusion of Rogers CJ Comm D. Olney J, dissenting in the result in that case, recognised that (at 157-158):

"A peculiar feature of s 556(1) of the Code is that personal liability may arise at a time removed from that at which the debt is incurred. This is so for the reason that the company may become one to which the section applies at a date subsequent to that at which the debt is incurred."

In Hussein v Good (1990) 1 ACSR 710; 8 ACLC 390, Southwell J, in a thorough consideration of the issue now before this Court, held that the phrase"incurs a debt" should be given a strict construction in accordance with the well established canon applicable to legislative provisions imposing criminal liability. So far as there was ambiguity about the phrase "incurs a debt", Southwell J held that it should be resolved by limiting the "debt" referred to to that which is actually owed immediately it is incurred so as to exclude contingent debts, such as those incurred upon the operation of a guarantee.

The foregoing decisions were criticised by Abe Herzburg "Insolvent Trading" (1991) 9 Company and Securities LJ 285 at 294ff. Herzburg's criticism affected Rogers CJ Comm D at first instance in the present case. Reaching his conclusion, his Honour said:

"... in circumstances where, between the date of an order and its due date for delivery, the financial position of the purchaser deteriorates to the point it cannot pay for the goods the purpose of an effective insolvency provision will be better served by the directors of the purchaser refusing delivery. Why should they accept delivery with impunity knowing the company cannot pay for the goods? Surely s 556 was intended to extend their personal liability in such a case. With respect to the fulfilment of the legislative purpose of preventing insolvent businesses from engaging in liabilities I was struck by [this] example... Assuming Company A incurs a debt in 1989. No grounds for invoking s 556 are present. However, in 1991, when the debt is still outstanding, Company A is insolvent. To obtain time, Company A procures a guarantee from Company B. If s 556 were to apply to contingent liabilities and therefore to guarantees s 556 would apply to Company B. It surely cannot have been intended that the section not apply simply because the guarantee of B is only a contingent debt. As it appears to me, there is nothing in the text of s 556 which could disqualify a contingent debt from inclusion in the expression 'debt'. The legislative history supports the inclusion. The purpose of the legislation is served by the inclusion."

Criticism of including contingent debts:

Against the conclusion adopted by Rogers CJ Comm D, the appellants mounted a number of telling arguments:

1.

The primary meaning of "debt" in its ordinary use in the English language is an obligation actually incurred. If a child incurs debts, it would not normally be said that the child's parent or guardian had themselves incurred such "debts" simply because, in the happening of certain contingencies, liability for those debts would fall upon them;

2.

The legislative history of the section is instructive. Section 374C of the Companies Act 1961 was expressed in these terms:

"(1) If an officer of a company to which this section applies was knowingly a party to the contracting of a debt by the company and had at the time the debt was contracted no reasonable or probable grounds of expectation... of the company being able to pay the debt, the officer is guilty of an offence against this Act." (Emphasis added.)

The phrase "incurs a debt" in s 556(1) of the Code, so it was argued, imports a narrower concept than "contracting of a debt" suggesting a legislative purpose to narrow liability under the subsection;

3.

Liability on a guarantee is ordinarily for the performance of an obligation so that the person having the benefit of the promise may, on default, sue the guarantor for damages for breach of contract: see Sunbird Plaza Pty Ltd v Maloney (1988) 166 CLR 245 at 255. But that is not to incur a"debt", which is a claim for liquidated damages. Incurring a contingent entitlement to unliquidated damages would not fit comfortably within the word"debt" within the section;

4.

So far as the "purpose" of s 556 is concerned, established authority enjoins a "sophisticated" and not an over simplistic approach, for the reasons explained by Mahoney JA in Metal Manufacturers Pty Ltd v Lewis ;

5.

In the event of fraudulent conduct on the part of a director, remedies exist under s 556(5) of the Code and orders may be made under s 557(2). That, so it was argued, was the way in which liability could justly be brought home to an officer of a company who wrongfully procured execution of a guarantee without stretching the net of s 556 as widely as the decision under appeal would provide;

6.

Although the concern of the Bank was to utilise s 556 in the pursuit of thecivil obligations of the officers of the company which gave the guarantee, the effect of the section, so widened, was to impose upon those officers criminal liability as well. By the orthodox canon of construction, such liability would not be imposed without clear authority of Parliament. The construction of the Code should be adopted which favoured the liberty of the subject; and

7.

The separation of the legal liabilities of directors and corporations lies at the heart of the conception of a corporation. It is crucial to company law. It was one of the chief causes which gave rise to the economic success of England and later other advanced economies such as our own. Such separation remains important for the entrepreneurial activities of corpor ations and is essential to the well being of the economy. It was said that the construction adopted by Rogers CJ Comm D would bring about consider able changes in the commercial world. It would potentially result in a number of corporations having no alternative but to cease trading for fear that their directors would otherwise assume personal liability and criminal responsibility. Such a radical change of corporation law was (so it was argued) one which should only be taken as achieved by Parliament if it used clear and unambiguous language. Furthermore, it was urged that it was one thing to render the officers of a corporation liable for the corporation's "debts" incurred at a time when the officer ought reasonably to have known of the insolvency of the corporation. It was quite another thing to impose liability in respect of execution of a guarantee, which might take place when the corporation was fully solvent and only become a source of obligations to the corporation years later, in circumstances unforeseen and even unforesee able at the time when the guarantee was executed. A construction of the section should thus be adopted which was consistent with the ordinary principle of company law whereby the obligations of the corporation were kept separate from the personal obligations of its officers.

So ran the arguments for the appellants.

Resolving the ambiguity:

I acknowledge the force of these arguments. I also acknowledge that there is an ambiguity in the Code which this Court must resolve. The proper approach to the task is plain. Both the common law and statute law enjoin the Court to give effect to the purpose of the legislation. But clearly, that purpose may be ascertained only within the words used by Parliament: see Re Bolton ; Ex parte Beane (1987) 162 CLR 514 at 518.

The expression "incurs a debt" in s 556(1) is, in isolation, entirely apt to describe an act on the part of a corporation whereby it renders itself liable to pay a sum of money in the future as a debt. The act of "incurring" happens when the corporation so acts as to expose itself contractually to an obligation to make a future payment of a sum of money as a debt. The mere fact that such sum of money will only be paid upon a future contingency does not make the assumption of the obligation any less "incurring" a "debt". As the Bank pointed out, many debts are incurred on a contingent basis. Goods are ordered by a buyer from a seller for future delivery. In such cases, the buyer is exposed to a future liability to pay the price upon delivery of the goods, absent some special condition requiring prepayment.

The legislative history of the progenitors to s 556 certainly included contingent debts and the debts to which those sections applied: see s 303(3) of the uniform Companies Act 1961. In Dunn v Shapowloff [1978] 2 NSWLR 235 at 242f, Mahoney JA held that a contingent debt was a "debt" for the purposes of s 303(3) of the Act. There is nothing in the decision in that case on appeal to the High Court which suggested that a contingent debt would, as such, be excluded from the language now used in s 556(1) of the Code: see (1981) 148 CLR 72 . To the contrary, Wilson J (at 84) clearly expressed the view that a debt payable on a contingency was a "debt" notwithstanding its contingent nature.

By the amendments of the uniform Companies Act in 1971, the By the amendments of the uniform Companies Act in 1971, the circumstances in which the personal obligations of the officers would arise were expanded: see New South Wales Parliamentary Debates (Legislative Assembly) 9 September 1971 at 910, 931. When the Act was replaced by the Code in 1982 it was clearly the intention of those presenting the Code to Parliament that s 556 would increase, and not reduce or limit, the obligations imposed upon officers of the corporation. It is apparent that, so far at least as the purpose of the legislature was concerned, nothing was done to reverse the interpretation which Mahoney JA had offered in Dunn v Shapowloff concerning contingent debts. On the contrary, the legislature, afterDunn v Shapowloff , followed a consistent line of expanding the personal liabilities of officers.

Several decisions have addressed issues raised by s 556. They include Halpern and Hussein as well as John Graham Reprographics Pty Ltd v Steffans (1987) 12 ACLR 779; 5 ACLC 904, Castrisios v McManus (1990) 4 ACSR 1; 9 ACLR 287 and B L Lange & Co v Bird (1991) 4 ACSR 715; 9 ACLC 1,015. Only the reasoning of Southwell J in Hussein is clearly adverse to the construction adopted by Rogers CJ Comm D.

There are good reasons of policy, in the achievement of the manifest purposes of s 556, to support the construction now under challenge. It would be absurd if an officer of an insolvent corporation could, with impunity, cause the corporation to enter into a guarantee of a liability which could immediately thereafter mature into an absolute obligation as a debt. The whole purpose or object of s 556 of the Code was to discourage officers of corporations from improvidently committing the corporation to obligations to pay money as a debt when they have reasonable grounds for supposing that their corporation is (or will, upon incurring the debt in question) become insolvent.

In such circumstances, where a choice of meaning exists and where one of the recognised meanings of "debt" extends that word in this very context to an obligation to pay on the occurrence of a contingency, it is a legitimate performance of the Court's task of statutory construction to accept the meaning which advances rather than frustrates the legislature's purpose. It is, after all, a defence to a criminal charge under s 556 if the defendant proves that the debt was incurred without his express or implied authority or consent or that he did not have reasonable grounds to expect that the company would not be able to pay its debts (see s 556(2)). As was explained in the Explanatory Memorandum which accompanied the Bill in 1981 (at 525):

"... This is a new provision ... designed to protect a person who either does not authorize incurring the relevant debt or does not realize that the company will not be able to pay its debts."

See also Companies Bill 1981, Explanatory Memorandum (at 525).

The construction urged for the appellants is not a necessary construction. It is one which defeats the achievement of the purpose of the legislation. It is one which defies both the legislative history and the statements which accompanied the legislative amendments which became the provisions of the Code under scrutiny. It is not therefore the construction which should be preferred, making full allowance for the fact that there is thereby also imposed a liability to prosecution for a criminal offence.

Conclusions and orders:

I agree in the conclusion of Gleeson CJ that once it is accepted that a "debt" in s 556(1)(a) may include a contingent debt, there is no difficulty in the present facts, in holding that a "debt" may be taken to have been incurred when Equiticorp entered a contract by which it subjected itself to a conditional, but unavoidable, obligation to pay a sum of money at a future time. This was such a case. It fell within the first of the two categories of guarantee identified by Mason CJ in Sunbird Plaza (at 255). There was therefore the incurring of a "debt" not merely the acquisition of a right to sue for damages. I agree with what Gleeson CJ has written about the character of the obligation assumed under the present guarantee.

The conclusion reached by Rogers CJ Comm D was therefore right. The appeal from his Honour's order determining the separated question should therefore be dismissed with costs.