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Brief Counsel

2012: Are you in the cross hairs for creditor claims?

13 February 2012

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Recent decisions from the courts have raised the legal risk for directors and underlined the exposure to third party liability of auditors, trustees and promoters. 

As a result, we can probably expect this year to have more claims made by receivers, liquidators and out-of-pocket investors against those involved in:

  • company governance and management

  • prospectus preparation, and

  • the provision of professional services.

So who is potentially in the gun, and why?

Directors

The risk profile attached to being a director was re-shaped in 2011 and made a lot more challenging, particularly for the directors of finance companies.  Three factors were at work.  They were (with links to the relevant Chapman Tripp commentary):

  • a number of cases in both Australia and New Zealand which explored the boundary between management and governance and established that, although directors may rely on expert advice, they cannot delegate their core decision-making functions 
  • law change, pending and actual, which raised the civil penalties to which directors are exposed and introduced criminal penalties for serious breaches of directors’ duties, and
  • the High Court ruling that directors may not access their insurance policies to fund the defence of criminal or civil proceedings if the costs would deplete the funds available to pay any successful civil claimant. 
    Civil claims against directors are likely to continue in 2012 as receivers and liquidators attempt to maximise recoveries for creditors. 

Also vulnerable are professional service providers, especially those whose role was to protect the company and/or its investors in some way.  We are already starting to see those cases begin to work their way through the courts.  Judgments delivered towards the end of 2011 may assist, and indeed encourage, some of those claims.

Auditors

The High Court was required to undertake a high level assessment of the merits of the claim by Nathan Finance’s receivers against the company’s auditors.  Although the issue arose in the context of a procedural question only, rather than a substantive trial, the judgment is instructive and highlights a potential exposure for auditors generally.

The judge considered that the claim raised a number of issues which required an answer, not least of which was the discrepancy between the $154 million of loans recorded in the audited accounts and the $6.5 million which the receivers had been able to recover. 

But of more general relevance was the High Court’s view that, although the losses suffered by Nathans were due mainly to lending decisions made by the directors, this did not absolve the auditors of all responsibility.  Instead the judge concluded that, if the receivers could establish that the auditors had been negligent, then that negligence could have caused the loss of money deposited by investors after the date at which the first financial statements were audited. 

Trustees 

The second judgment concerned an attempt by the trustee of National Finance’s debt securities to strike out a claim that the trustee owed statutory duties and common law duties (in negligence) to National Finance, in addition to those owed directly to investors. 

Although the judgment was again in the context of a procedural application, and not following a full trial, the High Court considered that it was in a position to make a binding and final determination as to whether the trustee, as a matter of law, owed the duties claimed. 

Associate Judge Bell ultimately determined that the trustee did not owe statutory duties to National Finance (as opposed to investors), but did owe common law duties in negligence, in addition to, or concurrent with, contractual duties imposed by the trust deed. 

The determination that the trustee owed common law duties to the company is important in two respects:

  • it avoids a potential statutory complication that other defendants may have faced in claiming contribution from the trustee, and
  • it may effectively defer the commencement of any limitation period, so as to enable claims to be brought later which might otherwise have been time barred.
The National Finance judgment is also significant for expressing the view that an indemnity granted by National Finance in favour of the trustee, contained in the trust deed, may be ineffective where a trustee fails to exercise due care and diligence.

Promoters

Parties who promote offers to the public are also more exposed following the Court of Appeal’s judgment in what has been referred to as the Feltex “class action”. 

To succeed in a claim against an auditor, individual investors must be able to show very specifically that they relied for their investment decision on particular language in the audit report and underlying accounts. 

However, in relation to promoters, the Court of Appeal left open the possibility that investors might need to satisfy a much lighter test, possibly as low as simply relying on third party advice (for example, from a broker or even from a news report) that was based on incorrect information contained in the prospectus.

The Court also left open the prospect of even more indirect reliance under a “fraud on the market” theory which postulates that investors are entitled to rely upon the protections offered by the regulatory regime itself.  In other words, had those preparing the prospectus complied with their obligation to ensure that all statements in the prospectus were true, the prospectus would never have been registered and investors would have suffered no loss.

Chapman Tripp comments

Some of the judgments may be appealed, and the effect of others may be nullified once the proceedings go to trial.  But the uncertainty creates opportunities for claimants and exposure to risk for potential defendants.  We therefore expect to see a continuation of such claims throughout 2012, especially as claimants attempt to access the proceeds of insurance policies.

For further information, please contact the lawyers featured.

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