Do your homework
A recent Court of Appeal decision shows that people who are contemplating accepting a company directorship at a time when that company is involved in the raising of share capital should do their homework to ensure the company has complied with the statutory requirements for capital raising.
This case, Chean v De Alwis2, has shown that where a company has breached statutory requirements, then a newly appointed company director can, in certain circumstances, be held personally liable for losses incurred by those who invest in the company where those losses stem from events that occurred before the director’s appointment.
The case
Mr Chean, owner of Luvit Foods, wanted to attract new investors to the company in order to expand its
business into a new venture. He provided various potential investors with a document referred to as an
‘Information Memorandum’ which, unfortunately, contained misleading statements and an improper
financial forecast. The potential investors were later found to be part of the ‘general public’ for the purposes of the Securities Act 1978 and, as a result, before seeking contributions, the company should have issued the requisite prospectus under that legislation; this it did not do. Nonetheless, people invested a total of $1,600,000 and these funds were variously received ‘on behalf’ of the company into a joint bank account controlled by Mr Chean and his wife personally.
Luvit Foods then failed, and the investors sued Mr Chean personally to recover their contributions. Mr Chean then declared himself bankrupt although the court proceedings went ahead, and the court found Mr Chean to be personally liable under the Fair Trading Act 1986 for the losses suffered by the investors. The court also found that a prospectus should have been issued.
Presumably, that outcome represented a hollow victory for the investors because they then brought a separate action against the owner’s wife. Mrs Chean was not a director at the time of the capital raising. However, she was subsequently appointed as a director and, in the hearing before the Court of Appeal, it was found nonetheless that the relationship between her and Luvit Foods at the time of the capital raising was sufficient to make her what the court referred to as a ‘privy’ of the company.
Despite the contrary arguments advanced by Mrs Chean, the court found that the money the investors had paid into the joint account was in fact subscription money. However, the court was not satisfied and ordered a retrial of the issue whether Mrs Chean actually knew that the allotment of shares to the investors was void under the Securities Act because of the absence of a prospectus and related Securities Act requirements.
If Mrs Chean did know of these requirements then she would have been bound by a statutory trust triggered by the Securities Act which would have left her personally liable to repay the investors.
And this is where the matter rests pending a further determination.
Conclusion
Although this Court of Appeal decision is likely to be relevant to very few company directors there is,
however, a sharp lesson to be learned for those contemplating company directorships – we recommend
you do your homework first.
