The chain of events which led to Bruce Davidson being banned under section 385 of the Companies Act from being a director, promoter or manager of a company contains lessons for other directors.
The ban was imposed by the Registrar of Companies in relation to Mr Davidson’s involvement with the collapsed Bridgecorp Group and was subsequently upheld by the High Court.
This Brief Counsel analyses the High Court judgment for the guidance it offers on when a director should either take appropriate remedial action – or walk.
Section 385 - the power to ban directors
To ban a director, the Registrar must be satisfied that the manner in which the affairs of the company were managed was “wholly or partly” responsible for the company’s insolvency and that the prohibition is “just and equitable”.
Mr Davidson argued that his actions as a director did not cause the Bridgecorp Group to become insolvent. But the Court concluded that it was not necessary to establish a causative connection to any particular director. The test was simply whether the company had been mismanaged, causing or contributing to the failure. If so, any director could be subject to a banning order, if that were “just and equitable”. In part, the Court adopted that approach by reasoning that any director in office when the mismanagement occurred had the opportunity to prevent it or, if it could not be prevented, to resign. This Brief Counsel focuses therefore on the Court’s interpretation of the “just and equitable” test. It is mainly this aspect of the judgment that will give guidance to directors.
Lack of Board control
In 2002, Group Managing Director Mr Petricevic bought a $1.65 million yacht using Bridgecorp funds. The Board, although not initially advised of this, had become aware of it by September 2004. But the Court noted that, rather than taking disciplinary action, the Board “merely made known its grave concern”.
The significance of the purchase was not that it contributed to Bridgecorp’s 2007 cash flow crises. Rather, its significance was that it demonstrated Mr Davidson’s inability to recognise that this “behaviour was unmistakable evidence of Petricevic’s dishonesty, his sense of entitlement to group funds, and his unwillingness to accept the Board’s authority”.
It was not Mr Petricevic’s misconduct, but rather Mr Davidson’s failure to respond, that evidenced bad governance. The judgment noted that, had Mr Davidson thereafter insisted on closer accountability and internal systems that reported the unauthorised use of money, Mr Petricevic would not have been able to “plunder the treasury” and the Group may not have entered into subsequent imprudent transactions.
The Court went on to state that Mr Davidson’s failure to insist on written reports to the Board, especially in light of Mr Petricevic’s conduct, was “compelling evidence that the Board was not in charge at Bridgecorp”.
Board on notice of potential insolvency
In June of 2006, Bridgecorp entered into the “Barcroft transactions”. These involved several loans being rolled into a single large loan committed to a property development in Fiji. They were agreed orally and consummated within two days, settlement occurring on 30 June 2006, with the paper work being drafted some time later.
Such extraordinary haste on the eve of balance date compels the inference that Bridgecorp needed to remove existing related party loans from its balance sheet. His Honour drew on this inference stating that “Davidson must have understood why the Barcroft transactions were being executed on balance date”. Moreover, at this stage Mr Davidson knew that new lending in New Zealand was at a standstill. It was also no secret that the Group relied heavily on continued investor confidence. This circumstantial knowledge together with the implied machinations surrounding the Barcroft transactions, are conditions that should, according to the Judge, have put Mr Davidson on notice that Group insolvency was a distinct possibility.
The relevance of expertise
In submissions Mr Davidson emphasised that he was not an accountant and had relied on management and other better qualified directors in financial matters. The Court accepted that the standard of care expected of a director depends on his or her position and responsibilities but held that it also depends on the nature of the company and the decision being made. A director must understand the fundamentals of the business, monitor performance and review financial statements regularly. Mr Davidson was not fully qualified for the office he held. But, he was one of only two independent directors and his presence and reputation might have encouraged investors to believe the group was well managed.
The Court’s conclusion emphasises that directors cannot rely on other board members when making important decisions, if they wish to avoid later prohibition. Directors must understand and be involved in making decisions, taking advice where necessary.
To resign or to stay on?
During the course of 2006, Mr Davidson had both threatened to resign and tendered his resignation – and was both times persuaded to stay. Mr Davidson justified his actions by saying that he “recognised his resignation would alarm the market and felt that the honourable course was to ensure Bridgecorp’s survival and prosperity”.
That Mr Davidson acted from honourable motives was not disputed. The National Enforcement Unit, the Deputy Registrar and Justice Miller all agreed that Mr Davidson stayed on as director out of a deep sense of duty and loyalty to Bridgecorp.
However, his Honour was clear that the ethical obligations a director may hold towards his or her company should not obscure the reality that investors, faced with large informational asymmetries and without much expertise, are often influenced by a director of good reputation continuing on in office - or not.
The root cause of the problem, namely the board’s fundamental weakness, stemmed from Mr Petricevic’s majority shareholding, as it meant that Mr Davidson could not dismiss him. The only way he could warn investors and other creditors of serious internal management difficulties was by resigning.
A careful assessment of the circumstances the Group found itself in over the course of 2006 should have given Mr Davidson, towards the end of 2006, enough information in order to reach the conclusion to resign. He could have done the Group and investors “no greater service”.
This case provides the following guidance for directors:
- be aware of collective responsibility – a director may be banned following mismanagement of a company caused by others, even where the individual director acts with the best of intentions
- ensure you have the necessary skills – a director must have the skills appropriate to the position held and the nature of the company, and
- a failure to resign when resignation is appropriate sends an inaccurate message to stakeholders and may well be relevant to the granting of later prohibition orders.
Our thanks to Nathan Jones and Rachael Irvine-Shanks for writing this Brief Counsel.