Criminalisation of directors’ duties – latest SOP provides workable outcome

12 June 2014

Criminalisation of directors’ duties – latest SOP provides workable outcome

Introduction

Over a period of almost 2 years, the office of Commerce Minister Craig Foss has spearheaded initiatives, under guise of lifting confidence, to criminalise “egregious” breaches of certain directors’ duties. Earlier this week a further Supplementary Order paper was tabled that, finally, provides a workable outcome.

In large part, the reason why this process has taken some time is because the Minister’s office has received some sternly-worded submissions pointing out the defects in the drafting (and logic) of some of the early attempts to implement these measures – in the form of amendments to the Companies Act 1993 to be achieved by means of the Companies and Limited Partnerships Amendment Bill.

To the credit of all concerned the Minister’s Office has undertaken further consultation and made strenuous efforts to strike the right balance between holding directors to account and not criminalising legitimate risk-taking.

Whilst the outcome, or likely outcome, that results from the latest (last) round of amendments, to be implemented by means of a Supplementary Order Paper that emerged earlier this week, herald changes to offence provisions that (when first tabled) sought to criminalise serious breaches of:

• the primary duty provided by section 131 of the Companies Act – the duty of directors to act in good faith and in the best interests of the company; and
• the duty in relation to ‘reckless trading’ provided by section 135 of the Companies Act – the duty of directors not to agree to, or cause or allow, company business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

I have been critical of earlier attempts to achieve the Minister’s objectives. And I recognise that there may be differences of opinion about the use of a very large stick to foster confidence-building. However, I am pleased to conclude that the latest round of proposals shows that the Minister and his officials have “met the market” by taking steps to address the major problems that have been identified by the consultation process.

The problem that criminalisation seeks to address

The criminalisation proposals were a response to the series of finance company failures and a desire in some quarters to include a form of punishment, in the form of lengthy jail terms, in the legislative armoury.

However, one of the key lessons from the finance company failures, is that the ordinary criminal law did apply where there was criminal offending – notably fraud. So, by extending criminal penalties into business decision-making processes, there is a high degree of risk that the legislature will simply frighten off good candidates who might otherwise be willing to take up a governance role.

In the outcome, the Minister and his Department have listened to the criticism and sought to manage the risk of criminalisation having a chilling effect on Board recruitment.

Outcomes from the SOP

The SOP removes the second offence (in relation to reckless trading). Instead, the SOP amends the existing offence provision in section 380 of the Companies Act (see below).

The SOP also changes the offence to be created in relation to the primary duty under section 131. Now, the offence is to become one of exercising powers or performing duties as a director of a company:

• in bad faith towards the company and believing that the conduct is not in the best interests of the company; and
• there must also be knowledge that the conduct will cause the company serious loss.

A director convicted of the offence is liable to imprisonment for a term not exceeding 5 years or to a fine not exceeding $200,000.

Dishonestly incurring a debt

As noted above, the second string to the proposals for criminalisation, in relation to ‘reckless trading’, has been removed by the SOP.

Instead, the SOP creates a new offence (expanding the existing offence provision for carrying on a business fraudulently). The new offence of dishonestly incurring a debt occurs where a company incurs a debt at a time when the company is insolvent (insolvency in this context means cashflow insolvency – being unable to pay its debts) or incurs a debt that, on its own or taken with other debts, has the effect of tipping the company into insolvency. In those circumstances, a director of the company commits an offence if:

• he or she knew of the existing insolvency or knew that the company would become insolvent as a result of incurring the debt; and
• the director’s failure to prevent the company incurring the debt was dishonest.

Concluding comments

On one level, the changes might seem to add little to the existing law. That is:

• a director who satisfies both limbs of the test to criminalise a breach of the primary duty in section 131 must be guilty of fraud; and
• the elements of dishonestly incurring a debt must also amount to fraud,

an offence that, as I have previously noted, has seen a small number of directors of failed finance companies practicing their gold swing at Her Majesty’s pleasure.

And, even in the absence of fraud, a number of finance company failures have resulted in successful prosecutions for offences where there was no actual dishonesty. Instead, the other offence provisions, particularly in the Securities Act, have been shown to work.

While I remain firmly of the view that the criminal law, in a business context – other than where it relates to danger to life and limb, should be confined to instances of criminal offending (such as fraud). In such cases, the penalties and remedies should be civil and focus on compensation for the financial losses suffered.

Nonetheless, it is heartening that the Minister and his officials have taken the criticisms on board, engaged with the market, and come up with solution that is free of the defects present in earlier drafts.  The challenge now is finding time in a busy order paper, with limited sitting hours before the election, for the Companies and Limited Partnerships Amendment Bill (as amended by the SOP) to receive its final reading.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.