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Criminalisation of directors' duties – another go, another disappointment

27 November 2013

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​The Government’s latest attempt to fix the problems with the proposed new directors’ crimes in the Companies and Limited Partnerships Amendment Bill falls well short of target.

The Supplementary Order Paper released last week, the second SOP to date on the Bill, proposes further amendments to the offences in Subpart 1 of the Bill that would criminalise the duties relating to ‘reckless trading’ and to not acting in good faith and the company’s best interests.

The proposals are flawed, and the flaws are not fixed by the SOPs.  Subpart 1 of the Bill should be abandoned.

The conundrum

After the distress created by the finance company collapses, the Government is anxious to rebuild public confidence in New Zealand’s capital markets.  It sees the criminalisation of directors’ duties as a way of achieving this objective.

However the effect of extending criminal sanctions into what is effectively normal business decision-making is inevitably to undermine the central and stated purpose of the Companies Act - this being to “reaffirm the value of the company as a means of achieving economic and social benefits through … the taking of business risks”.

This point has been made by local and international corporate governance experts in the context of the Bill again and again and again.  But, while the Government has fiddled with the drafting to try to accommodate the criticisms, it has not been able to resolve the central contradiction with the Companies Act nor to produce a formulation which will work in practice. 

Neither has a convincing case yet been made that there are any material gaps in existing directors’ crimes that need to be filled or would be filled by the Bill. 

Latest amendments

Reckless trading

In practical terms, the most problematic new directors’ crime is the one related to ‘reckless trading’.  Rather than sitting on top of the existing duty in section 135 of the Companies Act, as originally proposed, it is now an extension to the fraud provisions of section 380 of the Act. 

Among the problems with the revised provisions are:

  • the elements, which require a “serious loss” for one or more creditors, provide no proper boundaries to the application of the law.  The word “serious” simply means “not slight or negligible”.  As a result, it will not be possible for an adviser to say to directors that any loss to any creditor could not result in jail time for that director for consenting to the company carrying on, even if proper and reasonable steps are taken, and
  • the safe harbours designed to address the situation of legitimate workouts simply do not work either conceptually or in terms of their drafting. 

There is no easy fix to this, because the law already strikes a delicate balance in this area – including by providing personal liability for directors who inappropriately take their creditors for a ride and criminal liability for those who do so knowingly.

The aim was to address the damage that the Bill would inflict to the undertaking of solvent workouts.  But instead of incentivising directors to try to protect the stakeholders’ interests where there is scope to trade through, the Bill will increase the already significant incentives for them to minimise their personal exposure by ‘handing over the keys’ and sending the company into receivership or liquidation.

New best interests offence

The proposed new sections 138A and 138B, relating to the new criminal offence of acting other than in the best interests of the company, are a dangerous nonsense.

A nonsense because they would simply spray paint two extra pages into the corporate statute books to no practical effect as they are so narrowly drafted that they would achieve nothing. 

A nonsense also because they are unnecessary as they require knowing culpability, and there are sufficient remedies through the Crimes Act for deliberate offending.

It is difficult to envisage a director who had acted in bad faith, believing the conduct not to be in the company’s interests, and knowing or being reckless as to whether it would cause serious loss to the company not being found guilty of fraud or theft in a special relationship. 

The Serious Fraud Office and Financial Markets Authority have secured more than 20 convictions in the last 18 months in relation to the finance company collapses under the existing criminal law.  In most cases involving business decision making, the judge has been careful to state that the accused did not engage in intentional dishonesty.  So the changes would not yield a single conviction, on the same facts, that the current criminal law has missed.

Dangerous – and this is the important point – because the fact that the broadest of the directors’ duties is being criminalised will influence perceptions and will cause boards to become overly risk averse in their decision-making – to the detriment of economic innovation.

It will also discourage talented people from becoming directors, and without any corresponding policy benefit. 

Chapman Tripp comment

Everyone engaged in the debate around Subpart 1 of the Bill, in the original and through both SOPs, wants what the Government is trying to achieve – good governance with appropriate accountability.  The difference is over means, not over ends.

We contrast the deliberate, and sensible, choice in the Financial Markets Conduct Act 2013 and the Financial Reporting Act 2013, passed only last week, to focus liability for director disclosure failings on civil remedies rather than serious criminal penalties, except for conduct of a fraudulent kind.

The Government is promoting the Bill as part of its Business Growth Agenda.  Our view, shared by other submitters, is that the effect will be to create a drag on the economy by making boards unduly conservative.

We think the proposals in Subpart 1 of the Bill need serious re-thinking.

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