Director’s share trading scheme breaches fiduciary duties, but accessorial liability claims rejected

A recent Federal Court decision recognises the expansive reach of the statutory and fiduciary duties owed by company directors. However, the company’s unsuccessful attempt to hold third parties liable as accessories to its director’s breaches of statutory duties highlights the importance of properly pleading and proving that an alleged accessory has actual knowledge of all the essential facts constituting the director’s breaches.

In CellOS Software Ltd v Huber [2018] FCA 2069, the Federal Court found that Jason Huber (Huber), a founding director of CellOS Software Ltd (CellOS), covertly purchased and sold for profit his own shares in CellOS, instead of issuing new shares to raise capital directly for CellOS. In doing so, Huber was found to have breached his fiduciary and statutory duties owed to CellOS.

The Court also found that CellOS’ case against three alleged accessories, Mr and Mrs Peck (Pecks) and Mr Tan (Tan), was not made out as each lacked knowledge of, or relevant to, a number of matters critical to Huber’s breaches of his statutory duties.

Background

CellOS is an Australian public, but unlisted, software company. Huber, the company’s founder and Chief Executive Officer at the relevant times, was responsible for raising equity capital as CellOS’ principal (if not sole) source of funding.

CellOS brought proceedings alleging, in essence, that Huber had engaged in a fraudulent scheme whereby he created a secondary or ‘grey’ market for existing CellOS shares (including his own shares that were traded through ‘off-shore vehicles in exotic locations’), diverting investors away from investing directly in new equity, which operated to Huber’s own benefit and to CellOS’ disadvantage. It was further alleged that Huber used some of the profits from the share trading to loan funds to CellOS on terms that were commercially favourable to him, and that he did so without disclosing his interest in the lending entities to CellOS’ board. CellOS claimed that by carrying out this scheme, Huber breached his fiduciary duties and his statutory duties to CellOS under sections 181, 182 and 183 of the Corporations Act 2001 (Cth).

CellOS also claimed that the Pecks and Tan, who had purchased shares through Huber and on-sold them, were liable to CellOS as accessories to Huber’s breaches of duty. However, at trial CellOS abandoned its general law (second limb Barnes v Addy) claims that those respondents had knowingly assisted Huber in a dishonest and fraudulent scheme, leaving only claims that they were ‘involved in’ Huber’s breaches of his various statutory directors’ duties.

The diversion of a corporate opportunity

A noteworthy aspect of this case (described by the judge, Justice Beach, as one ‘rich in facts’) is that a director of an unlisted company was held to have breached a number of the duties he owed to the company by trading in the company’s shares.

As Justice Beach observed in his reasons for judgment, there is no per se restriction on a person transacting the sale of shares of a company of which he or she is a director. This is because a company is usually not concerned with who buys shares in itself, share trading by a director is ordinarily undertaken in the person’s capacity as shareholder, not as director, and because a company is not usually in the line of business of buying and selling shares in itself – the sale of its own shares is not ordinarily a business opportunity that the company could or should take up.

However, the Court found that Huber’s conduct amounted to a diversion of a corporate opportunity, which breached his fiduciary and statutory duties owed to CellOS. This was essentially because:

• CellOS was not trading profitably and was substantially dependent on Huber’s ability to raise equity or debt to continue its operations
• Huber was the officer primarily responsible for raising equity capital for CellOS
• CellOS was always contemplating equity raisings, such that selling shares was within or associated with CellOS’ ‘line of business’
• at all relevant times, Huber was aware that there were willing buyers of CellOS shares, who could have invested in CellOS directly
• instead of procuring those potential investors to buy new shares issued by CellOS, Huber diverted those investors to buy shares from him through a series of offshore companies he controlled
• CellOS had an ‘interest and expectancy’ in potentially issuing new shares to the investors who were ultimately diverted by Huber’s conduct
• Huber then caused companies he controlled to enter into loan agreements with CellOS that benefited him, without disclosing his interest in the lending entities

Huber argued and gave evidence to the effect that a number of the offshore companies he was alleged to control were in fact used by others to transact in CellOS shares without his knowledge, and that CellOS’ board was aware that the companies through which he loaned funds from his (admitted) share trading activities to CellOS were controlled by him. However, the Court rejected that evidence, finding Huber to be an unreliable witness, whose evidence was evasive, argumentative and inconsistent with evidence given in previous proceedings and with contemporaneous documents and other objective evidence.

Huber was ultimately found to have breached his statutory duties, having failed to act in good faith in the best interests of CellOS and for a proper purpose, improperly used his position to advantage himself and cause detriment to CellOS, and improperly used information obtained as a director to gain a personal advantage and to cause detriment to CellOS. His conduct also breached equivalent and additional fiduciary duties owed to CellOS under general law.

Claims against the alleged accessories

CellOS also sought to impose accessorial liability on the Pecks and Tan on the basis that they were said to be knowingly involved in Huber’s breaches of his statutory directors’ duties.

CellOS contended that the Pecks and Tan either had knowledge of each essential element of Huber’s wrongful conduct or, alternatively, were ‘wilfully blind’ to Huber’s conduct such that their failure to make further enquiries should therefore be taken to amount to actual knowledge. However, Justice Beach found that the Pecks and Tan had no actual knowledge of a number of the essential aspects of Huber’s contraventions, and was not prepared to draw inferences of wilful blindness.

The Court agreed that the ‘apparently official nature’ of the CellOS presentations attended by the Pecks, at which they were encouraged to purchase CellOS shares through Huber, would have ‘put any reasonable person in their position off making any enquiry’ as to the source of the shares, noting further that the circumstances were ‘such as to reassure the Pecks and put them off any enquiry that someone in their position might think to make’ and that Mrs Peck had believed that ‘CellOS was aware of and condoned the secondary or grey market’.

Of particular interest is that the Court considered the absence of CellOS’ informed consent to Huber’s activities itself to be an essential fact in Huber’s contraventions for the purpose of the accessorial claims. Accordingly, it was for CellOS to plead and prove that the Pecks and Tan knew Huber was acting without the CellOS board’s fully informed consent. This was so notwithstanding that in respect of CellOS’ primary claims against Huber, informed consent was a positive defence required to be raised by Huber – rather than absence of informed consent being an essential element of the primary claim. The Court held in this regard that the Pecks did not know that Huber lacked the informed consent of CellOS’ board, and moreover that this had not been pleaded.

Key points

The CellOS v Huber decision is a timely reminder for company directors to reflect on the strict and extensive general law and statutory duties they owe to the company. Directors should be cognisant that the scope and content of their duties are not fixed and, in appropriate circumstances, those duties may proscribe acts which would ordinarily be uncontroversial, such as buying and selling shares in the company (although the circumstances giving rise to Huber’s liability for his share trading scheme were particularly unusual).

The decision may also stand for the proposition that a company seeking to impose liability on an alleged accessory to a director’s breach of statutory duty must plead and establish that the alleged accessory had actual knowledge that no defences – such as fully informed consent by the company – were available to the director in respect of the impugned conduct.

(Hall & Wilcox acted for Mr and Mrs Peck, two of the successful respondents in the proceeding.)