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We would like to
welcome you to the June edition of the Koffels E-Newsletter.
We hope you find this publication informative and that it provokes consideration
of some of the day to day legal issues you, or
your clients might face.
If you require further information about any of the topics covered in any
of our E-Newsletters or legal assistance generally please feel free to
contact Ross Koffel on (02) 9283 5599
Recovering payments made by directors to a third party
It
is not uncommon for the sole director/secretary of a
private company to use company monies which is debited
to the director's loan account or otherwise to be
re-paid. However, while this practise may not be
uncommon, directors are in a fiduciary relationship with
the company and company money used by the director to
meet private obligations may be deemed a breach of their
fiduciary duty and recoverable where there is sufficient
knowledge of the breach by a third party who is the
recipient of the money.
This
was successfully demonstrated in a recent case in which
Koffels was involved.
The
case involved two companies, controlled by a common
director ("the director"), operating a laundry business.
The assets of the business were owned by one while the
business was operated under the other. The business was
later sold to a third party, and $555,000 from the
proceeds of sale was paid to Mr Baloglow, a previous
director of one of the companies and to whom the
director had a personal obligation for payment of a
judgment debt. Shortly after the sale, the two companies
were placed in liquidation.
Koffels
were instructed by the liquidator of the companies and
successfully recovered the $555,000 incorrectly paid to
Mr Baloglow under the first limb of Barnes v Addy
(1874) LR 9Ch App 244 in the NSW Court of
Appeal.
The
Court viewed that the sale of the business disposed of
the only income-earning asset of the two companies, and
the absence of the $550,000 paid to Mr Baloglow
"prejudiced creditors" as the operating company was to
pay the other company for lease of equipments.
Furthermore, the fiduciary duty of a director of a
company facing insolvency also extends to the interests
of its creditors.
The
Court held that in this case, the director, who must
have been aware of the risk if he gave any thought to
the interest of creditors, was therefore in breach of
his fiduciary duty when he diverted the proceeds of the
sale to Mr Baloglow.
However,
in order to succeed under the first limb of Barnes v Addy, it
was necessary for the liquidator to demonstrate that,
not only was there a breach of fiduciary duty, but that
Mr Baloglow who received the money had either actual or
constructive knowledge of the director's breach of
fiduciary duty.
The
5 categories of knowledge are stated in Baden v Societe General SA
(1993) 1WLR 509, being:
- actual
knowledge;
- wilfully
shutting one's eye to the obvious;
- wilfully
and recklessly failing to make such inquiries as an
honest and reasonable man would make;
- knowledge
of circumstance which would indicate the facts to an
honest and reasonable man; and
- knowledge
of circumstance which would put an honest man on
inquiry.
It
was argued for Mr Baloglow that he had no knowledge, and
could not have had knowledge, that the companies were
insolvent. Therefore, in the absence of that knowledge,
the claim could not succeed under the first limb of
Barnes v
Addy.
However,
the court held a different view, being that Mr Baloglow
did not require actual knowledge of the solvency of the
companies.
Mr
Baloglow, who was a previous director of one of the
companies, was aware that the laundry business was owned
by one company and operated by the other. He was also
aware that the money he received was from the proceeds
of the sale of the business, and had it been
appropriately used would have been for the operating
company to pay its debt to company with legal ownership
of the equipment. Instead, the funds from the sale of
the business was used to satisfy the director's personal
debt to Mr Baloglow and not a liability of the
companies, and Mr Baloglow knew that the operating
company could not otherwise pay the amount owed to the
other company.
The
Court held that on these facts alone, an honest and
reasonable man in his position would know that the money
he received would in fact be a breach of the paying
director's duty to the companies, without having regard
to the interests of creditors, and on this basis there
was Barnes v
Addy liability.
However,
the Court nonetheless continued to discuss the issue of
knowledge in relation to creditors and added that Mr
Baloglow should have been aware, or at least be put on
inquiry, of the creditors, based on evidence before the
court.
It
was not necessary for him to have actual knowledge of
the creditors, nor the amount outstanding. Based on the
evidence, at the very least, he was told that income was
severely down and that there was difficulty in paying
creditors. The Court held that an honest and reasonable
man with his knowledge would have seen a real and not
remote risk that creditors would be prejudiced, and on
this basis also, there was Barnes v Addy
liability.
The
Court of Appeal held in favour of the liquidators and
ordered the return $555,000 plus interest to the
companies as well as an order to pay the liquidator's
costs.
An
application for leave to appeal to the High Court was
refused.
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About the Firm
The firm commenced operation in 1990 when Ross Koffel decided to return
to full time legal practice after 20 years in business as the Chief
Executive Officer of a national advertising and film production
company.
Today KOFFELS Solicitors and Barristers are a prominent boutique commercial
firm located in the CBD Sydney.
KOFFELS has a reputation for being a hard and diligent negotiator and
litigator.
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