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Federal Court of Australia |
Last Updated: 8 March 1999
Australian Securities Commission v Forem Freeway Enterprises Pty Ltd
CORPORATIONS LAW - Company involved in retail sales of computers - respondent sole director and shareholder - large deposits paid by customers - failure to fulfil customers' orders - inadequate financial records kept - information withheld from liquidator - absence of even informal record keeping - penalised for complaining - monies from customers often not banked - continuous stream of complaints - meagre attempts to remedy poor record-keeping - no material to rebut presumption of insolvency pursuant to s 588E - actual insolvency - company unable to pay debts as and when fell due - company cheques frequently dishonored - dishonesty and unreasonable behaviour - failure to keep financial records considered in relation to dishonest and unreasonable conduct - outstanding orders resulted in net liability - non payment of sales tax - absence of intention to defraud outright - does not preclude finding of unreasonable and dishonest behaviour - reasonable person would realise insolvency - conscious deception of customers - "cross-firing operation" - dishonest dealings with hire-purchase lender - trend in legislative regulation of greater concern to prevent directors' misconduct - prohibition against managing corporation protective in nature - likely capacity of harm to public - prohibition not punitive - deterrence and hardship relevant to the question of penalty - legal capacity to manage not a matter of necessity but a privilege - whether permanent disqualification appropriate - no capacity to pay penalty - prejudice to rehabilitation considered - liberty to apply
Australian Securities Commission Act 1989 : s 13
Bankruptcy Act 1966 : ss 82(3AA), 149, 149A
Corporations Law: ss 95A, 91A, 121, 286, 588E, 588G, 588H, 588J, 1317DA, 1317E, 1317EA, 1317EF, 1317F, 1317HA,
Chorley and Smart, Leading Cases in the Law of Banking (Sweet and Maxwell, London, 5th ed, 1983) [referred to]
Friend v Corporate Affairs Commission and Another (1989) 7 ACLC 106 [cited]
NW Frozen Foods Pty Ltd v Australian Competition and Consumer Commission [1996] FCA 1134; (1996) 71 FCR 285 [referred to]
Re Tasmanian Spastics Association; Australian Securities Commission v Nandan (1996) 23 ACSR 743 [referred to]
Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 [cited]
AUSTRALIAN SECURITIES COMMISSION v FOREM-FREEWAY ENTERPRISES PTY LIMITED & ORS
NG 3199 of 1997
MADGWICK J
4 MARCH 1999
CANBERRA (HEARD IN SYDNEY)
IN THE FEDERAL COURT OF AUSTRALIA BETWEEN: Applicant AND: First Respondent Second Respondent Third Respondent JUDGE:
NEW SOUTH WALES DISTRICT REGISTRY NG 3199 OF 1997
AUSTRALIAN SECURITIES COMMISSION
FOREM-FREEWAY ENTERPRISES PTY LIMITED
NET ADMIN PTY LTD
KEITH DAVID MORTON
MADGWICK J DATE: 4 MARCH 1999 PLACE: CANBERRA (HEARD IN SYDNEY)
THE COURT ORDERS THAT:
1. DECLARE pursuant to s 1317EA of the Corporations Law that the third respondent has contravened each of ss 232(2), (4) and 588G(2)(b) of the Corporations Law in relation to the first respondent by the following acts and omissions:
(a) procuring the solicitation and acceptance on behalf of the first respondent from members of the public of substantial sums of money in the form of pre-payments for the sale of computer equipment, when the first respondent did not have any such equipment available to it nor the financial resources to obtain that equipment;
(b) by failing to prevent the first respondent from incurring debts to Australia and New Zealand Banking Group Limited, Alfa Computers Pty Limited and Also Technology Pty Limited, when a reasonable person in the third respondent's position would have been aware that there were reasonable grounds for suspecting that the first respondent was insolvent; and
(c) by procuring the diversion to the second respondent of the amount of $80,158.67 out of funds provided by Advance Leasing Limited for the sale to Advance Leasing Limited of computer equipment, being the subject of a Hire Purchase Agreement between the first respondent and Advance Leasing Limited.
2. ORDER pursuant to s 1317EA(3)(a) Corporations Law that the third respondent be prohibited from managing a corporation for 12 years from 25 September 1997.
3. ORDER pursuant to s 1317HA(1) Corporations Law that the third respondent pay compensation to the first respondent in the amount of $200,000.
4. ORDER that the applicant have further liberty to apply in relation to the order it has sought pursuant to s 1317EA(3)(b) of the Corporations Law upon 21 days notice to the third respondent.
5. ORDER that the third respondent pay the applicant's costs of the proceedings to be assessed or taxed.
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| NEW SOUTH WALES DISTRICT REGISTRY | NG 3199 OF 1997 |
|
BETWEEN: | AUSTRALIAN SECURITIES COMMISSION
Applicant |
|
AND: | FOREM-FREEWAY ENTERPRISES PTY LIMITED
First Respondent |
| NET ADMIN PTY LTD
Second Respondent | |
| KEITH DAVID MORTON
Third Respondent |
|
JUDGE: | MADGWICK J |
| DATE: | 4 MARCH 1999 |
| PLACE: | CANBERRA (HEARD IN SYDNEY) |
"8. Orders under s 1317EA(3) of the Corporations Law prohibiting the third respondent from managing a corporation and requiring him to pay to the Commonwealth a pecuniary penalty in accordance with s 1317EA(3)(b) ...Factual Background
9. An order under section 1317HA of the Corporations Law requiring the third respondent to pay compensation to the first respondent.
10. Alternatively or in addition, an order under section 588J of the Corporations Law requiring the third respondent to pay compensation to the first respondent's creditors."
2 Mr Morton was the sole director, shareholder, and the secretary of Forem at the relevant times and had been so since 4 September 1996. He was responsible for the day to day management of the company and was, indeed, its sole manager. Until the intervention of the court, Forem had carried on the business in Newcastle of assembling and retailing personal computers and allied equipment. Its method of operation was to solicit large cash deposits of 50% of the sale price from members of the public in return for the promise to supply to them a computer package in approximately 2-3 weeks time.
3 Since at least 30 June 1997 the company had no significant realisable assets or cash with which to obtain supplies of the computer equipment which its customers had ordered. The cost price to the company to fulfil outstanding customers orders was in the region of $2,000 for each order. By August 1997 at least 200 purchasers, who had each paid deposits in the region of $1,000, were yet to be provided with their purchases. In the end, in many cases, the customers did not receive the equipment for which they had paid such substantial deposits and were left to lament their lot among the unsecured creditors of Forem. Apart from the possibility of Mr Morton's recovery in the present proceedings for the benefit of Forem, there is no prospect of any dividend being paid to these or other creditors in the company's winding up.
Legislative framework
4 Under s 232(2) of the Corporations Law an officer of a corporation is required at all times to act honestly in the exercise of his or her powers in the discharge of the duties or his or her office. Section 232(4) requires that such an officer must, in the discharge of his or her duties, exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the circumstances of the corporation.
5 Section 588G deals with a director's duty to prevent insolvent trading. The effect of s 95A is that if a corporation is not able to pay all its debts as and when they become due and payable it is to be treated as insolvent. A director of a company contravenes s 588G and becomes liable to, among other things, a civil penalty if he or she fails to prevent a company from incurring a debt when the company is insolvent (or would become so on incurring the debt) and there are reasonable grounds for suspecting that the company is insolvent. It suffices if the director is aware that there are reasonable grounds for suspecting the insolvency or if a reasonable person in a like position in a company in the circumstances of the subject company would be aware of such grounds for suspicion.
6 Section 588H provides various defences to s 588G proceedings such as illness preventing the director from taking part in the management of the company at the time, or that the director reasonably believed that, somebody else was responsible for providing adequate information about the company in insolvency, that person was fulfilling that responsibility, and, therefore, it was expected on the basis of such information that the company was solvent.
7 Section 1317DA provides that, among other provisions, subss 232(2) and 232(4) and s 588G are "civil penalty provisions". Section 1317EA applies if the Court is satisfied that a person has contravened a civil penalty provision. It obliges the Court, in such a case, to declare that a person has so contravened such a provision in relation to a specified corporation. Under s 1317EA(3) the Court is empowered to make an order prohibiting such a person from managing a corporation for such period as is specified in the order. Additionally or alternatively, the Court may make an order requiring that the person pay to the Commonwealth a pecuniary penalty of a specified amount that does not exceed $200,000. Under s 1317E, an application for orders of that kind may be made by, among others, the ASC. Section 1317EF(1) provides that a person so ordered not to manage a corporation must not manage a corporation except with the leave of the Court and, under s 1317EF(3), the Court may attach such conditions or restrictions as it thinks appropriate to any such leave. Managing a corporation in this context is constituted by being a director or promoter of, or being "in any way (whether directly or indirectly) concerned in", or being one who "takes part in the management of", a corporation: s 1317F(2) and s 91A(2).
8 Pursuant to s 1317HA, where the Court is satisfied that a person has contravened a civil penalty order provision and has caused loss or damage to the corporation by the commission of the contravention, the Court may, in addition, order the person to compensate the corporation to a specified amount.
9 Section 588J provides further sanctions in relation to a contravention of s 588G. Where the debt incurred by the insolvent company is wholly or partly unsecured and the creditor has suffered loss or damage in relation to the debt because of the company's insolvency, the Court may order the offending director to pay to the company compensation equal to the amount of that loss or damage.
10 The matter of insolvency, for the purposes (among others) of s 588G, is further dealt with by way of a presumption for which provision is made under s 588E. If it is proven that a company has contravened s 286(1) by failing to keep accounting records that correctly record and explain its transactions and financial position and enable true and fair accounts of the company to be prepared and audited, then it is rebuttably presumed that the corporation was insolvent throughout the period in which that failure to keep accounting records occurred. "Minor or technical" contraventions are to be disregarded for this purpose.
11 I referred to the availability of certain defences under s 588H in relation to proceedings for a contravention of s 588G. I should say at once that, on the facts admitted and proved in the present case, there is no basis for finding that any such defence was established or might apply.
The ASC's contentions as to breaches of the Law
12 The report of the corporation's affairs provided by Forem's liquidator and verified by Mr Morton estimated a deficiency in the winding up of $433,000. There were $10,000 worth of assets and an estimated $443,000 in liabilities. Notably, the debts included;
(a) retail customers of Forem, owed $200,000. This was said to be based on a "list supplied by [the] liquidator" less certain excisions thought appropriate by Mr Morton;
(b) $48,000 owed to a trade creditor, Alpha Computers Pty Limited ("Alpha");
(c) $85,000 owed to Advance Leasing ("Advance"); and
(d) $47,000 owed to the ANZ Bank ("the Bank").
13 It is the contention of the ASC that Mr Morton;
(i) failed to act honestly in exercising his powers and discharging his duties as a director (s 232(2)); and/or
(ii) failed to exercise reasonable care and diligence in relation to those functions (s 232(4)); and/or
(iii) failed in his duty to prevent insolvent trading by the company (s 588G),
in relation to:
(a) the company's solicitation and acceptance from members of the public of money for the sale to them of computer equipment when the company had neither such equipment nor the financial resources to obtain it;
(b) failure to prevent the company from incurring debts to the Bank, Alpha and Advance when he should have suspected that the company was insolvent;
(c) arranging the diversion to the second respondent of approximately $80,000 from funds provided by Advance for the acquisition by it of certain computer equipment and the lease, by hire purchase, of such equipment to the company.
Inadequate financial records
14 There is, as mentioned above, an extended concept of insolvency for the purposes of s 588G, which brings the adequacy of the company's financial records into sharp focus. In addition, their adequacy may bear on the questions of the honesty and reasonableness of Mr Morton's conduct.
15 The liquidator, Mr Hicks, received certain books and records of the company from the ASC in his capacity as provisional liquidator. The ASC had been provided with these during an investigation of the company under s 13 of the Australian Securities Commission Act 1989 on 6 August 1997. Mr Robert Donovan, who was said to have been the accountant for the company, handed over these records and informed the ASC that he held no other records relating to the company. The ASC had possession of other company records from the NSW Police Service which had obtained those records under a search warrant. Further, company records, it would seem, were withheld by Mr Morton from the liquidator. Viewing the matter charitably, this may have been on the assumption that the liquidator and the ASC had the company's computer records which ought to have duplicated the original documents that Mr Morton had. He produced these in the course of the hearing of the current proceedings. The further documents produced by Mr Morton do not materially affect conclusions reached by the liquidator nor my own conclusions.
16 Before the hearing of this matter Mr Morton did not provide the liquidator with any books or records. The liquidator's unchallenged evidence was that the materials provided to him, from all sources, did not comply with the requirements of s 286 of the Corporations Law. It will be recalled that these requirements are that the financial records should both correctly record and explain a company's transactions, financial position and performance and also enable true and fair financial statements to be prepared and audited. Quite apart from the failure of the company's records to have contained any general ledger reporting the balances of assets, liabilities and shareholders' funds from time to time or even a cashbook showing records of moneys paid to the company and payments made by it, there was no less formal record which would enable any of that information to be accurately obtained. For example, there were numerous cheque butts recording cheques issued on the bank account of the company, but these failed to disclose such information as the name of the payee or the purpose of the payment for which a particular cheque was paid. Indeed nothing so basic was kept as reliable and systematic recording of the monies received in the course of business from customers.
17 It will be recalled that Mr Morton's estimate of the amount due from the company to its customers on liquidation was $200,000 and that he had so estimated this "based on [a] list supplied by [the] liquidator". The list in question had in fact been prepared by the NSW Department of Fair Trading ("the Department"), which had been concerned about the company, and was passed on to the liquidator. That list contained the names of 291 customers of the company who together had paid a total amount of $276,594, payments having been made at varying times between 21 April 1997 and 14 July 1997. Mr Morton's account of how he arrived at the estimate of $200,000 (being money owed to those who had failed entirely to receive the goods for which they had wholly or in part paid) was that he examined the Department's list and excluded a number of the claimants referred to in it because he believed that those customers had in fact received their purchases. There were also, as I understood Mr Morton's claims to the liquidator and the Court, some duplications or "nil balances"; some customers to whom moneys had been refunded, and even some quite fictitious customers. This belief was based upon details which were disclosed in the company's copies of invoice/receipt forms kept for those customers.
18 However, Mr Morton had instructed company staff to indicate to customers that if they were complaining to the Department the company would deal with such a complaint "as it arises". Such people would be "penalised simply by the length of time that the process takes". It would, Mr Morton told the ASC examining officers, "take a long time before all those alleged complaints [were] actually heard" by the Consumer Claims Tribunal. He had also caused customers to be told that if they withdrew their complaints from the Department their computers would be completed more quickly. Thus, there would be reason to believe that some unhappy customers would have concluded that their interests were better served by not making a complaint to the Department. Of course, the names of such customers would not appear in the Department's list of customers with unmet obligations.
19 Mr Morton said that the invoice/receipt forms were the only method, apart from banking records, by which the company recorded its cash receipts and therefore the only means from which one could identify how much had been received and from whom. The company did not deposit all of its cash receipts into its bank account. Sometimes cash was simply retained at the premises and disbursed in favour of suppliers, employees or to Mr Morton. An employee in a position to know said that, between December 1996 and late June 1997, cash from customers was rarely deposited in the bank account. Her evidence was unchallenged. Ms Macpherson, employed as the company's office manager on 28 June 1997, found hundreds of the invoice/receipt forms lying in three piles; one for orders which had been satisfied; one for outstanding orders, and; one for orders where refunds had been made. It is convenient also to note her observation that the pile for then outstanding orders nominated a variety of stipulated supply dates in April, May and June.
20 On the face of the documentation, especially the invoice/receipt forms, it appeared that a great many customers had been given an "estimated completion date" of not later than 30 June 1997 but as there was no entry of payment of the balances it appeared that no equipment was ever provided. Mr Morton denied the general proposition that hundreds of thousands of dollars had been received from consumers without their orders having been satisfied by the stipulated time of completion. He could not, however, satisfactorily explain why the invoice/receipt forms indicated otherwise. Ultimately, he agreed that the only way of knowing which orders had in fact been fulfilled and which had not, would be to contact each of the people referred to in the forms.
21 It needs no emphasis that this is a failure of a very high order to comply with s 286. So basic a matter as what the company's liability, if any, was to a particular customer could not confidently be determined. Without that foundation, it would be quite impossible to keep records that might explain the company's financial position and performance or that would enable any of the conventional financial statements to be prepared, let alone audited.
22 Mr Morton's answers to this were, firstly, that while the company was operating things were not so bad as they had appeared to be at the trial due to the fact that his memory of particular customers had faded and, secondly, that he had taken steps by the appointment of Mr Donovan, who in turn had encouraged Ms Macpherson's engagement, to have the records put in proper order. However, Ms Macpherson gave evidence of "a continuous stream of complaints ... about overdue computers" which took up the bulk of her time as an employee of the company. She was told by Mr Morton to blame the company's competitors for causing difficulty with its suppliers. She said that, by Friday 11 July 1997,
"it had become virtually impossible for me to deal with customer complaints about the non-supply of their computers and still continue to take deposits from new customers. The situation had become so bad that, whenever customers became irate about not receiving their computers, I would seek approval from Mr Morton either to refund their deposits or to appease them by giving them computer equipment such as a monitor or a printer or speakers, off the floor. Even though we had an ever-increasing backlog of unfilled customer orders, we were still taking deposits from new customers for computers. At the insistence of Mr Morton, we were still quoting delivery times of 21 days. I recall one occasion when a staff member ... was admonished by Mr Morton for quoting a delivery time in excess of 21 days over the phone."23 There is ample material, in my view, to justify the inference that the extent of the company's net asset deficiency in Mr Morton's report to the liquidator was understated by a substantial amount. This understatement and the necessarily indeterminate amount of it are at least in part the consequence of there being no adequate record keeping system. In the light of Ms Macpherson's evidence, such steps as Mr Morton had taken to remedy the matter were plainly too little too late and had scant prospect of ever achieving their purpose if the company had been allowed to continue trading.
Actual insolvency
24 There is no material which would rebut the presumption of insolvency to which the failure to keep proper accounting records gives rise pursuant to s 588E(4). However, to my mind, it was clearly shown that the company was actually insolvent at all material times. In the first place the liquidator gave unchallenged evidence that, by the beginning of June 1997 the company was unable to pay its debts as and when they fell due and was insolvent. The liquidator concluded that "nothing Mr Morton said would persuade me to the contrary that from April 1997 a significant number of customers had paid deposits on computers but [they] neither received by or within a reasonable time of the date for which they had contracted to get the equipment for which they had paid, nor had they had a refund of their deposits". The company's cheques were frequently dishonoured, 50 of them between 1 January 1997 to 24 July 1997.
25 Mr Morton's account of matters was that the principal cause of the company's failure was a public warning issued by the NSW Minister for Fair Trading on 30 June 1997 which, while it did not name the company, warned customers in the Newcastle area against paying large deposits for the purchase of computer equipment. However this led, Mr Morton said, to an outflow of approximately $100,000 in the first fortnight of July 1997, by way of refunds of customers' deposits. Of course the Minister's announcement was likely to diminish the flow of customers to the company and to enlarge the number demanding their money back. However what exactly happened in relation to the company's funds cannot be determined and Mr Morton's evidence should not necessarily be accepted; the bank statements and cheque butts disclosed that, during the first two weeks of July 1997, 35 refunds amounting to $31,560 were made, in comparison to 17 refunds amounting to $18,860 for the preceding fortnight.
Dishonesty and unreasonable behaviour
26 The truth is that the method of trading was fundamentally unsound and, to put matters at their most benign, the consequence of under-capitalisation of the business, a failure to comprehend and deal with its precarious nature and disregard of ordinary commercial morality in dealing with the company's customers and others. Mr Morton's method was to try to undercut other dealers not tied to large wholesale distributors of brand-name equipment (such as IBM and Compaq), by trading at a low profit margin and building a large volume of trade in order to obtain supplies cheaply. Instead of a deposit of modest order, say 10%, being taken from customers to show their good faith about completing the transaction, deposits of the order of 50% of the retail price were sought. Such deposits were treated as part of the company's general revenue and used to buy computer components generally, not only on a one-off basis for a particular customer who had ordered some particular equipment and paid the deposit. At most times, the suppliers of computers and related gadgetry were insisting on payment of the price of what was ordered from them upon order (not even on a cash on delivery basis) or at best with a very short credit period. Staff wages and other general expenses of the company also needed to be paid.
27 The whole affair was a house of cards. It depended on the continual expansion of the business. It is true that Mr Morton, somewhat belatedly, had in active contemplation the need to break that necessity by introducing another revenue stream. He had ideas for providing training services to the company's customer base and providing them with Internet services. But those opportunities and ventures would no doubt have had difficulties of their own.
28 The unsoundness of the whole scheme is exemplified by Mr Morton's attitude to outstanding orders from customers who had paid deposits for the purchase of computer equipment but whose orders had not been satisfied, so that they still owed the balance of the purchase price. Mr Morton thought of these outstanding monies due to the company as "assets" and did not seem to take proper account of the fact that the goods had not been supplied to the customers. In fact, the outstanding balances of purchase price comprised the credit side of an outstanding financial transaction which resulted in a net liability, since in virtually every case the cost of providing the equipment to the customer would exceed the outstanding balance to be paid by the customer.
29 Further, it seems that no sales tax was ever paid by the company and, of course, no provision was ever made for it. The only method by which the extent of that liability could be calculated would be by reference to the details of the sales which it made. Given the state of the company's records, that task is a practical impossibility. However, it would seem likely that the extent of the company's deficiency in this respect was further understated in Mr Morton's Report as to Affairs to the liquidator.
30 All this material gives rise to an overpowering inference that the company was trading insolvently for a considerable number of weeks before 30 June 1997 and afterwards.
31 That Mr Morton did not subjectively intend outright to defraud customers of the company cannot avoid a conclusion that his behaviour in this regard was both unreasonable and dishonest. Any reasonable person in the position of a director of the company in its circumstances must have realised that at any given time its liabilities substantially exceeded its assets and that, by reason of the dishonoured cheques and the practice and/or entrenched fact of excessive delays in meeting customers' orders, the company could only meet its debts as they fell due by falling into default in relation to obligations to customers. That is not an ability to pay debts as they fall due, and any reasonable person would understand this. The extent of what I have called the entrenched fact of excessive delays in meeting customers' needs and the established practice of making unrealistic representations to them about how soon and how reliably they would get their equipment indicates that the boundary between self-deception as to the company's prospects and conscious deception of its customers had been crossed, and crossed at Mr Morton's behest. That was, in the ordinary meaning of the word, dishonest behaviour in relation to the affairs of the company.
32 Two other sets of transactions reinforce the conclusion of dishonesty. The first concerns the company's bank. In July 1997, the company had no approved overdraft facility, at least not one that would support a de facto overdraft of the extent which the company managed to obtain by the technique, apparently well enough known and an established risk against which banks need to guard, called a "cross-firing operation": see Chorley and Smart, Leading Cases in the Law of Banking (Sweet and Maxwell, London, 5th edn. 1988) pp 219-20. The supposed accountant Mr Donovan was Mr Morton's accomplice in what might fairly be called a caper. A number of valueless cheques drawn on bank accounts operated by Mr Donovan were deposited to the company's account. These were followed in very quick succession by repayments by the company's own valueless cheques to various accounts controlled by Mr Donovan. Through an error in banking procedure, the bank was left an unsecured creditor in the winding up to an amount in excess of $48,000. Those funds, wrongfully procured, were quickly expended in the operations of the company and there is now no company asset which in any way corresponds with or reflects any of the money thereby obtained.
33 The literary wit Don Anderson recently remarked of one Australian poet's account in an encyclopedia of the work of another that the word "judicious" was barely adequate to describe it. The same, it seems to me, might be said of the observation of the learned author of Chorley and Smart of this kind of practice. He said that it is "not easy to see how the practice can ever be entirely innocent". Mr Morton's account of this matter was quite disingenuous and he denied Mr Donovan the experience of the witness box.
34 Inferences, however overwhelming, apart, arrant dishonesty was shown in dealings with the company's hire-purchase lender. The lender, Advance, was provided with an invoice for the sale to the lender of certain computer equipment for $110,000 on the stationery of an entity known as Mag Tech Computer Services. The lender and the company then entered into a hire-purchase agreement in relation to those goods. The lender provided a bank cheque to finance the purchase of the equipment on 15 August 1997. The cheque was made out to Mag Tech Computer Services. Mr Morton thereupon "cancelled" the purchase of the equipment and arranged with Mag Tech's proprietor that he be given two cheques; one of these, apparently for a shade under $30,000, was directly deposited to the bank account of the finance broker who had arranged the loan. Out of this money, the first instalment of $25,000 due under the hire purchase agreement was paid and the balance, $80,158, was paid by cheque to the second respondent (Net Admin), another Morton creature. Mr Morton deposited that amount and drew it out very soon afterwards in cash. He paid some of the cash to himself and some to others. In interlocutory proceedings before Sackville J on 5 September 1997 his Honour required Mr Morton to identify his application of those cash amounts by reference to documentary material where available. The identification proffered was inadequate. On Mr Morton's own account, he eventually bought equipment, of a kind which the hire purchase lender's officers believed they were financing to the extent of $110,000, for $42,000. Mr Morton asserted that the price of the equipment had dropped markedly in the months of negotiation and since the time that the hire purchase lender was first approached. Be this as it may, there is no doubt that Mr Morton, in his capacity as a director of the company, behaved quite dishonestly in his dealings with the hire purchase lender. There was associated dishonesty by way of overstatement of Mr Morton's own position as potential guarantor of the loan, but I view that as of less significance than simply borrowing $110,000 for the express purpose of acquiring $110,000 worth of equipment but then in fact acquiring $42,000 worth of such equipment and using the balance at his own discretion.
35 Given the chaotic nature of the company's records and finances, at the time the sum of $80,158 was paid by Mr Morton's direction (and indeed by him personally) into the bank account of Net Admin, without Net Admin providing any service directly to the company, it cannot be said that Mr Morton had any honest and/or reasonable purpose for doing this. He may or may not have ultimately arranged the disbursement from Net Admin of that amount to various creditors of the company, including himself, but what he did was not something which an honest or even a reasonable person, acting as a director in the then circumstances of the company, would have done.
36 Since, in my view, Mr Morton's honesty must be impugned, the degree and circumstances of such dishonesty will of course be highly relevant to the subsidiary relief sought by the ASC. It is appropriate, therefore, that I should say something of my assessment of Mr Morton's motivation. In his favour, I think that he did not intend any wholesale defrauding of members of the public nor did he intend that any of them should actually suffer loss. He was a relatively young man in too much of a hurry. His plans to remain and succeed in the kinds of business ventures that he was engaged in, through this company and Net Admin, depended on his having a large and reasonably well satisfied customer base. He was not a mere confidence trickster. On the other hand, losses were in fact incurred by a large number of people in the Newcastle district by reason of his egregious mismanagement of the company which was in fact dishonest and unreasonable. He was the sole director and shareholder and the blame is entirely his. He displayed a quite insufficient appreciation of this and was inclined to blame the NSW authorities for doing that which they had a plain duty to do, to protect new people from being enmeshed in arrangements with the company which would imperil their money, in most cases likely to have been hard-earned.
37 At the time of the hearing, Mr Morton had learned little; he was engaged in a basically similar business on his own account. That he was prepared to engage in this business on his own account and so assume personal liability to customers does not in the circumstances show any special improvement in his commercial conduct. He had no net assets to speak of and was accordingly risking nothing but a loss of legal status via bankruptcy. His conduct in this regard should be seen as a last desperate throw of the dice.
Disqualification
38 It is not easy to discern a legislative policy, consistent in its details, in relation to this matter. However, something of a trend in legislative regulation of company directors is apparent. At present the Corporations Law includes the following provisions:
* Pursuant to s 229 an undischarged bankrupt and persons convicted of various kinds of offences (including fraud or dishonesty), punishable by imprisonment for as little as 3 month (see s 229(3)(b) and the definition in s 9 of "serious fraud"), are automatically disqualified from "managing" a corporation (see above) for 5 years. If they were sentenced to prison for the offence, they are indefinitely disqualified. The section is not clearly drafted. In either case the Court may relieve them, conditionally or otherwise, from such disqualification.
* Under s 230, the Court may on the application of the ASC (or some other "prescribed person") prohibit from company management an officer who has failed to take reasonable steps to prevent a corporation repeatedly breaching regulatory legislation. The prohibition is for such period as the Court thinks fit. Apparently there is no power in the court later to relax such a prohibition.
* Section 599 empowers the Court to prohibit management by a person who has, in effect, been involved in the management of two or more insolvent corporations where such management has contributed to the insolvency. Again, there is no power to modify the prohibition.
* Section 600 enables the ASC to order a director of two or more companies that, on winding up, paid unsecured creditors 50 cents in the dollar or less, not to manage another corporation for up to 5 years subject to the leave of the Court.
* Finally, there is the provision presently involved, s 1317EA(3)(a). Section 1317EA(1) empowers the Court, where a person has contravened a "civil penalty provision" to make an order prohibiting the person from managing a corporation for such period as the Court specifies. This power is expressly made available whether or not the contravention also constitutes an offence by reason of its having been made (among other things) knowingly, recklessly or dishonestly, under s 1317FA. The Court is not to make an order if it is satisfied that, despite the contravention, the person is fit and proper to manage a corporation. Pursuant to s 1317EF, the Court may, conditionally or otherwise, give leave for such management.
39 The present regime appears to have acknowledged the problems of misconduct by directors and other company officers that have, in some cases scandalously, come to notice in recent years. The duties and liabilities of such persons have been made more onerous. Ormiston J recognised this tendency in 1990 before the "civil penalty provision" device was introduced. He said, in Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405, at 412-3 that,
"there can be little doubt that a more rigorous approach should now be taken by the Courts in the light of the scope of remedies thereunder and of other legislative changes".I agree that the Courts should, by their practical decisions, reflect the values inherent in and apparent from the trend of legislative standard-setting.
40 The Corporate Law Reform Act 1992 introduced the "civil penalty provisions" and amendments to s 232(4), requiring the exercise of objectively reasonable care and diligence of company officers. Among other things, the recommendations of the Australian Law Reform Commission ("the Harmer Report") were implemented. One of the purposes of the new Part 5.7B (wherein s 588G is to be found) was to ensure that directors would act to prevent insolvent trading by a company. Part 9.4B, dealing with the civil and criminal consequences of contravening the "civil penalty provisions" involved acceptance of a Senate Committee's recommendations to reserve criminal liability for conduct considered to be "criminal in nature" (para 61 Explanatory Memorandum) and to provide a range of other civil remedies in other cases. There appears to have been something of a compromise; enlarged liabilities and duties and more effective remedies civilly, for some confinement of the criteria of criminal liability. Civil proofs were assisted by, among other things, the provision of the rebuttable presumption of insolvency referred to above.
41 I take it to be trite law that the purpose of the power in the Court to prohibit an errant company officer from managing a corporation is protective of the public. This has fortunate and unfortunate consequences for the wrongdoer. He or she should, on the one hand, not be subject to any enlargement of the period of prohibition by reasons of or deriving from misplaced conceptions of punishment, such as "general deterrence". On the other hand, any hardship to the person concerned must play a lesser role in moderating a period of prohibition otherwise appropriate.
42 For reasons such as these, where a penalty is sought as well as a period of prohibition and a compensation order, it seems to me desirable to deal with the protective and compensatory aspects before the question of a penalty. There is ample authority that questions of deterrence and hardship are relevant to the quantum of any penalty: see for example NW Frozen Foods Pty Ltd v Australian Competition and Consumer Commission [1996] FCA 1134; (1996) 71 FCR 285 and Re Tasmanian Spastics Association; Australian Securities Commission v Nandan (1996) 23 ACSR 743 at 752 per Merkel J.
43 A consequence of the protective character of a prohibitory order is that attention needs to be focused on the likely capacity of the person concerned to do harm to the public and the multifarious ways in which such harm might be done. As Powell J put it in Friend v Corporate Affairs Commission and Another (1989) 7 ACLC 106, at 115,
"the function of s 562A of the Code [an equivalent to s 600 of the Corporations Law] is to protect the public - not merely the investing public, but ordinary business [people] and tradespeople who might deal with the company - from the depredations of, and from losses which might be caused by the activities of dishonest, unscrupulous, untrustworthy, irresponsible, or merely incompetent, company directors" (emphasis added).44 The losses of the customers of the company in this case, were caused, as I have indicated, more by irresponsibility and incompetence in running a company than by outright dishonesty, although, as I have also explained, the latter element was not lacking. That is of no comfort to such customers. The loss to the hire-purchase lender was caused by frank dishonesty. Its loss is not thereby the greater.
45 It is quite clear that the protection of the public requires that Mr Morton be prohibited from engaging in the management of a company for a substantial period. That period should, in my view, be long enough that one can reasonably and confidently predict that, by its expiry, he will have mended his ways. There is, in general, no necessity for an individual to have the legal capacity to manage a company. It is a legal privilege to be able to do so; most people manage to make a living without doing it. The ability of the Court to grant leave on conditions, upon an application to it, can deal with any reasonable need of Mr Morton to manage a company in circumstances in which members of the public and business people will not be put at risk. The leave provisions can also be availed of in the event, as is to be hoped, that Mr Morton can prove that his attitude and his management skills have sufficiently changed before the expiry of the period that I have now to fix.
46 The ASC submits that something that is, for practical purposes, a permanent disqualification - a period of 30 years was suggested - ought to be imposed. The analogy of financial dishonesty on the part of a solicitor was suggested. It is not, in my view, especially apt. Nothing requires that a company director shall have studied law or ethics or have been able to prove good character before limiting his/her ordinary legal liabilities with the aid of a two-dollar or any other company. Solicitors have special privileges, and special opportunities for doing harm to people by malfeasance on their part, which are not accorded to company directors.
47 I prefer to look at what Mr Morton's proven conduct indicates as to the future. He has displayed financial incompetence, a cavalier disregard of vital record-keeping, unreasonable judgments as a company director and an incapacity to realistically face his own problems in business or the problems his business activities caused for others, including many vulnerable others. He has shown a preparedness to disregard serious legal obligations after they had been brought to his attention and a degree of dishonesty. Despite his business plan being founded on an unsustainable premise - indefinitely continuing growth - he intended phoenix-like to arise from the Forem ashes and continue in the same methods, using some other trading entity or entities, including his own name.
48 Losses were thereby caused to many people who could doubtless ill-afford it and whose only folly was naive trust in pursuit of a bargain, as well as to corporations well able to look out for themselves and to absorb losses, and to others.
49 The conclusion I draw is that not until Mr Morton has entered a different phase of his life as to his likely ambitions, judgment and acceptance of his limitations, ought he be in a position such that he can exercise any degree of substantial direction of the affairs of a company, without close, competent and effective supervision. The future is of course unforeseeable, but people do, in general, have a capacity to learn from experience. In any case, age may or may not confer wisdom, but it does usually slow down the unduly ambitious. As a practical matter, I think one can be reasonably confident that, in 12 years time, Mr Morton is likely to be sufficiently mature and therefore sufficiently likely to understand the wisdom of fulfilment of legal duties, to enable him to be trusted again at or close to the helm of a company. I would not be confident that a lesser period would suffice.
Compensation
50 This may be ordered either under s 588J or s 1317HA. The latter source of jurisdiction seems appropriate and it also seems appropriate to exercise the jurisdiction. The precise assessment of the compensation might be a difficult matter but, having regard to the unlikelihood of much, if any, of it being recovered, this is not a case that calls for precision. The ASC seeks a compensation order in the sum of $200,000. This is conservative; it is less than the entire estimated deficiency, which might well be attributable to Mr Morton's culpable mismanagement.
51 I therefore order that he pay compensation to the company in the sum of $200,000. He has now been made bankrupt. His inevitable discharge from bankruptcy (see ss 149 and 149A Bankruptcy Act 1966 ) will extinguish his liability for such compensation. To that extent, there is likely to be little, if any, actual added hardship to Mr Morton from such an order.
Penalty
52 Clearly, if Mr Morton had any capacity to pay, this would be a case, in principle, for the imposition of a substantial penalty. However, he appears to have no such capacity. Unlike a compensation order, an amount ordered to be paid by way of penalty is not provable in bankruptcy: s 82(3AA) Bankruptcy Act 1966. In consequence, a discharged bankrupt would, subject to the ordinary civil law, remain liable to pay such a penalty out of post-bankruptcy assets or earnings.
53 Although not intended to have this effect, the orders that I have made are likely, one way and another, to cause Mr Morton some degree of disability in finding work and some general distress. The conduct he has engaged in has led to his being made bankrupt. His ability to engage in business activities, to which he is evidently drawn, will be severely impaired. His ability to engage in such activities by way of corporate activity will be so impaired for a long time. These matters will, inescapably, have a punitive effect upon him, albeit an unintended one.
54 At the end of his bankruptcy, the effect of the kind of large penalty order that might otherwise be appropriate ($50,000 was proposed by the ASC) would simply be to make him indebted to the Commonwealth. So far as his personal capacity to earn a living is concerned, any prejudice to his potential rehabilitation would need to be carefully considered. If he has no capacity to pay, the infliction of such a debt is a somewhat pointless exercise. If he then has a presently unforeseen capacity to pay, the position may be different.
55 I think the case is best dealt with by giving the applicant liberty further to apply in relation to this matter. There is not the same necessity as in the case of criminal punishment to let offenders promptly know their fate. It might be, for example, that if Mr Morton comes into funds, any penalty that he might then be ordered to pay could be considerably moderated by voluntary compensation that he might make for the benefit of the retail customers who, in most cases, presumably suffered some hardship from their losses. In saying this, I cannot, of course, and do not intend to, bind the Court in any way in its future consideration of the matter.
|
I certify that the preceding fifty-five (55) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable
Justice Madgwick. |
Associate:
Dated: 4 March 1999
|
Counsel for the Applicant: | Mr S Epstein |
| Solicitor for the Applicant: | Australian Securities Commission |
| Counsel for the 1st, 2nd and 3rd Respondents: | Mr W Warwick |
| Solicitor for the 1st, 2nd and 3rd Respondents: | Cornwells Solicitors and Advocates |
| Date of Hearing: | 27 May 1998 |
| Date of Judgment: | 4 March 1999 |
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