De-ductive reasoning – Liquidators win de-facto director dispute

Introduction

On 10 May 2021, the Supreme Court of Victoria handed down its judgments in an insolvent trading proceeding instituted by the liquidators of Walsh Engineering Services Pty Ltd (in liq) (“the Company“). The liquidators were successful in proving that both directors, one of whom was found to be a de facto director, engaged in insolvent trading. The judgment usefully discusses the relevant factors to consider when dealing with a suspected de facto director.

De facto directors

There are two types of persons who classify as directors:

1. persons who are formally appointed as directors or alternative directors; and
2. persons who are not formally appointed as directors, but who act in the position of a director, or who the directors of the company are accustomed to act in accordance with the instructions or wishes of.

The latter category of persons are de facto or shadow directors.

The case

Mrs Walsh was a formally appointed director of the Company during the period in which the Company incurred debts (“relevant period”). Mr Walsh was a formally appointed director of the Company prior to, but not during, the relevant period.

Mr Walsh admitted that he ran the Company, along with other related “Walsh companies”, and that Mrs Walsh had no involvement in the Company’s operations.

In deciding whether or not Mr Walsh as a de facto director, the Court considered several cases, including:-

• The seminal Full Court of the Federal Court of Australia case Grimaldi v Chameleon Mining NL (No 2), where a director of a consultancy company was found to be a de facto director of the company to which the consultancy services were provided (“client company”). The director had directed the client company’s corporate strategy in a significant acquisition and had involved himself in the day to day running of the company.
• The recent case of Yeo, in the matter of Bradi Transport Pty Ltd (in liq) v Sklenovski, where the liquidators (represented by Hunt & Hunt) proved that the husband of a director, who effectively controlled the company’s operations, including its bank account, was a de facto director.
• Deputy Commission of Taxation v Austin, where the court held that, in determining whether a person is a de facto director, consideration should be given to:

1. 1. the size of the company;
   2. the company’s internal practices and structure;
   3. the nature of the functions and powers which are exercised by the person, including any delegation or discretion given to the person; and
   4. whether the person is held out as a director to third parties.

Decision

As a result of their failure to comply with the Court’s orders, Mr and Mrs Walsh’s defence was struck out. They were therefore taken to have admitted the allegations of facts in the liquidator’s statement of claim.

Without evidence to the contrary, the Court found that it was “clear” from Mr Walsh’s actions that he was the “controlling mind” of the Company. In particular, Mr Walsh:

• was a signatory to the Company’s bank account;
• managed the Company’s day to day operating activities without reporting to, or seeking approval from, Mrs Walsh;
• made the decision to appoint voluntary administratorsto the Company;
• held himself out to as the managing director of other companies in the Walsh Group of companies; and
• worked in and for the Walsh group of companies on a full-time basis.

Consequently, Mr Walsh was a de facto director within the scope of s 9(b)(i) of the Corporations Act 2001 (Cth) (“Act”).

Given that both Mr and Mrs Walsh were directors during the relevant period, and were unable to make out a statutory defence, the Court found that they had contravened s 588G of the Act by failing to prevent the Company from incurring a debt when the Company did not have the capacity to meet it. Mr and Mrs Walsh were liable to compensate the Company the sum of $484,829.54 plus interest in accordance with s 588M of the Act. The liquidators were also entitled to recover $238,604.16 plus interest from the Walsh Group on account of its indebtedness to the Company.

Take aways

The Court’s decision usefully discusses the circumstances in which a liquidator will be entitled to recover compensation from a de facto director for loss incurred by a Company from insolvent trading.

Those involved with the management of a company which has been placed in liquidation should be aware that, even if they have not been formally appointed as director, they may still be found liable for insolvent trading in certain circumstances.  In particular, their involvement in managing the company, making decisions or holding themselves out to be in effective control of the company, may be evidence used to establish their position as a de facto director.

~ with Helen Hodgins, Lawyer