Australian Securities Commission v Donovan, John Phillip & Anor [1998] FCA 986

FEDERAL COURT OF AUSTRALIA

CORPORATIONS - directors’ duties - duty of care and diligence contained in s232(4) of the Corporations Law - whether breach of duty - whether prohibition from managing corporation should be imposed - considerations for imposing prohibition - whether contravention “serious” - whether civil pecuniary penalty ought to be imposed.

Corporations Law s232(4), s1317EA

Federal Court Rules

Daniels v Anderson [1995] 37 NSWLR 438 - Appl

Francis v United Jersey Bank 432 A 2d 814 (NJ 1981); 37 NSWLR - Cons

Re Property Force Consultancy Pty Ltd (In Liq) [1997] 1 Qd R 300 - Appl

Vrisakis v Australian Securities Commission (1993) 9 WAR 395 - Appl

Re Tasmanian Spastics Association; ASC v Nandan (1997) 23 ACSR 743 - Appl

Nicholas v Corporate Affairs Commission (1987) 5 ACLC 258 - Cons

Friend v Corporate Affairs Commission (1989) 7 ACLC 106 - Cons

Re Civica Investments Ltd [1983] BCLC 456 - Appl

Cullen v Corporate Affairs Commission (1989) 7 ACLC 117 - Appl

Trade Practices Commission v Stihl Chain Saws (Aust) Pty Ltd [1978] ATPR 17,882 - Cons

NW Frozen Foods v Australian Competition and Consumer Commission (1996) 71 FCR 285 (FC) - Appl

AUSTRALIAN SECURITIES COMMISSION v JOHN PHILLIP DONOVAN AND JULIA GWENDOLIN DONOVAN

No QG 3006 of 1997

COOPER J

BRISBANE

20 AUGUST 1998

IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY	QG3006 of 1997

BETWEEN:	australian securities commission Applicant
AND:	john phillip donovan First Respondent julia gwendolin donovan Second Respondent
JUDGE:		COOPER J
DATE OF ORDER:		20 August 1998
WHERE MADE:		BRISBANE

THE COURT DECLARES THAT :-

1. By causing or permitting the Good Life Company and Friends Pty Ltd to continue between November 1995 and October 1996 to sell growerships and quota to Kefir growers in the absence of any market and in disregard of contrary expert advice, the respondents have contravened section 232(4) of the Corporations Law in relation to the said corporation.

THE COURT ORDERS THAT :-

2. The first respondent is prohibited from the date of this order for a period of ten years from managing a corporation as defined in s91A of the Corporations Law.

3. The second respondent is prohibited from the date of this order for a period of three years from managing a corporation as defined in s91A of the Corporations Law.

4. The first respondent pay to the Commonwealth the sum of $40,000 by way of a civil pecuniary penalty pursuant to s1317EA(3)(b) of the Corporations Law.

5. The second respondent pay to the Commonwealth the sum of $4,000 by way of a civil pecuniary penalty pursuant to s1317EA(3)(b) of the Corporations Law.

6. The respondents pay the applicant’s costs of and incidental to the application including reserved costs, if any, to be taxed if not agreed.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY	QG3006 of 1997

BETWEEN:

australian securities commission

Applicant

AND:

john phillip donovan

First Respondent

julia gwendolin donovan

Second Respondent

JUDGE:	COOPER J
DATE:	20 august 1998
PLACE:	BRISBANE

REASONS FOR JUDGMENT

Introduction

The applicant is the Australian Securities Commission (“the ASC”). The respondents at all material times were directors of The Good Life Company and Friends Pty Ltd ACN 055 573 969 (“Good Life”).

On 25 November 1997 the ASC filed an application seeking orders under s1317EA of the Corporations Law (“the Law”) against the respondents. The application was supported by a statement of claim filed on the same day.

On 12 December 1997 I made an order for substituted service of the application and statement of claim on the first respondent under O7 r9(1) of the Federal Court Rules. The application and statement of claim were taken to have been served on the first respondent at the expiration of one month from service being made in accordance with the order for substituted service: O7 r9(2). The second respondent was served personally.

On 13 January 1998 the first respondent sent an e-mail to Mr Niall Coburn, a legal officer with the ASC. The e-mail was sent by the first respondent to his brother to be relayed to Mr Coburn. A copy of the e-mail was also forwarded to the Court. I am satisfied from the contents of the e-mail that the first respondent was aware of the proceedings against him and the nature of the claims being made against him. The e-mail showed a post office box address and an e-mail address for the first respondent.

On 21 January 1998 the ASC filed a notice of motion seeking judgment against the respondents pursuant to O11 r23(1)(b) in default of each of them filing and serving a defence on or before 16 January 1998 as directed. On 27 January 1998, in accordance with a direction of the Court, an e-mail in the following terms was sent to the first respondent :-

“Dear Mr Donovan,

I have been directed by the Federal Court of Australia to serve you with a notice of motion advising you that there will be a hearing on the application of the Australian Securities Commission (ASC) on the 9th March 1998 at 10.15 am in the Federal Court of Australia in Brisbane. In those proceedings the ASC will seek a declaration pursuant to section 1317EA(2) of the Corporations Law in relation to allegations that you contravened section 232(4) of the Corporations Law by causing or permitting the Goodlife Company and Friends Pty Ltd to continue between October 1995 and October 1996 to sell growerships and quotas to Kefir growers in the absence of any market and in disregard of contrary expert advice. The application and the affidavits to support the ASC’s case have been previously served by court order on your post office box and your brother and sister in Brisbane. I understand this information has been brought to your attention.

The ASC will be asking the court for an order that you be prohibited from being a director or managing a corporation for such a period that the court deems fit and that you pay to the Commonwealth a pecuniary penalty and the ASC’s costs in the proceedings. You may contact me by return email or on (07) 3867 4731.

I attach for your consideration a copy of the notice of motion in relation to the hearing on the 9th March 1998.”

The notice of motion was listed for hearing at 10.15 am on 9 March 1998. On that date the second respondent appeared and with the agreement of the ASC was given leave to be represented by an agent, Mr Garry Taylor. Prior to the commencement of the hearing an envelope containing a letter and a bundle of papers was delivered to the Court by courier. The envelope and courier’s notification disclosed the sender as Mrs Rosalind M Burgess of Carrara Heights, Queensland. Mrs Burgess is the first respondent’s sister.

The letter, dated 3 March 1998, so far as presently relevant said :-

“With the limited resources available to me in India, I offer my defense [sic] in this written form, and in place of my physical absence (for reasons I established in my previous letter to His Honour Mr Justice Cooper, of The Federal Court of Australia, dated March 13th, 1998).

Please accept this and excuse my lack of legal etiquette. I am not a lawyer, and have had no legal advice in this matter. Further I am unsure of the charges and have not been able read [sic] the affidavits presented by the ASC due to communications problems to do with the part of India I am living [sic]. I am however well aware of the persistent nature of a relatively few who have been intent on destroying the Goodlife Company and Friends and bringing some kind of retribution down upon me. I am therefore deeply concerned that the outcome of this Trial does not allow this painful drama to further ruin my life and the lives of the people that had faith in my Companies Stated Mission.

In short ‘to provide products and services which gave people the opportunity to create a better quality of life’.

I speak for myself in this matter, in so far as, my co-director and wife at the time, had little to do with the operations of the company, except for a brief period immediately prior to taking the Company into Voluntary Administration.

I am lead [sic] to believe that she is being represented in this matter by her own legal counsel and trust that she will act according to her conscience. In so doing, I am convinced that she supported me in my work as a dutiful wife, sure of my integrity and that my intentions were of the highest caliber [sic].

The little information I do have leads me to believe that the ASC is going to try and prove that I sold business’s [sic] without having a market big enough to sustain the subsequent Kefir production and make the payments to Grower/Creditors.

I will challenge that assertion on these grounds.

The Markets were more than big enough.

The ASC has been motivated by and misled by revengeful individuals with an axe to grind.

Those whose opinion has been sort [sic] in connection with the Charges against us have no validity as these people had then or now:

no knowledge of the extent or size of the markets for Kefir, its value and indeed have little or no understanding of the product and its value to mankind full stop.

no knowledge of the Health Food market.

no knowledge of the size or extent of the market for Pro-biotics.

no knowledge of the Skin Care and Cosmetics Market.

no knowledge of the Market for Kefir related Agricultural Products, especially Organic Bio Fungicides, Animal Feed Pro-biotics, Catalytic Silage Enhancing Bacteria and Preservatives.

no knowledge of the Weight Management/Diet Food Market.

no knowledge of Post Operative nutritional food market.

no knowledge of Cancer Research and in particular the studies done with regard to Kefir and other Lactic Acid Bacteria and Cancers of the Intestinal System.

very little or no knowledge of the Historical, Cultural, Global significance that Fermented Milks, including Kefir have played and are continuing to play, in feeding on a daily basis over half of the population of our planet.

no knowledge or understanding of the role that ‘home grown’ Fermented Milks such as Kefir, play the Earths ecologically precious environment. The very same environment that so many First World citizens, are now so avidly trying to protect.

That the failure of the Company was not a forgone [sic] conclusion reached previously and based on limited accounting opinion. The failure had more to do with the decision to go into Voluntary Administration which stemmed from the incorrect tax accounting of the consultant accountant recommended by our Management consultant and poor accounting by our own company accountant. It also had more to do with the malicious, unscrupulous nature of The Creditors Committee, who lead a small band of desparate [sic] and angry Grower Creditors right down the road to control of the Company and subsequent bankruptcy.

That the failure of The Goodlife Company and Friends was a directly and unequivocally assured by business restrictions placed upon our company in the process of Voluntary Administration. This vary [sic] same Administration also supported my dismissal and therby [sic] depriving The Goodlife Company of the most important knowledge available to it.

That I alone had the authority of experience, knowledge and vision necessary to judge the size of our markets and likely success of The Goodlife Company and Friends. Such knowledge convinced me that the opinions proffered by various people, lacked substance and were discounted. Their opinions were based on accounting formulaes [sic] with static figuers [sic] not allowing for the eventual restructuring of debt, Joint ventures overseas and sales of products.

That our rapid company growth created challenges, which demanded innovative solutions, which we found and were working on in all areas. Due to the unique nature of our products we had arbitrary control of the market price for which we bought Kefir stocks from the Growers. This allowed for many possible solutions to increasing Grower Payments. At the time of going into Voluntary Administration, a prospectus was being researched and planned. This Prospectus would have radically reduced our Grower Payments by trading Equity in the Company for decreased monthly returns for the Growers and subsequent reduced monthly overheads for our Company.

After taking legal advice, upon the resignation of a temporary accountant, the understanding I have of Company Law in this area says that, ‘Directors who increase Company debt knowing that such debt can not be repaid are liable for prosecution’. I did not sell Kefir Growing Businesses to repay existing Grower Debt believing that such sales would eventuate in unpayable debt. The sale of such businesses did in fact support our debt payments but its primary role was to fund development of Kefir products, build the factory’s [sic] needed, and pay for the marketing. Additionally, I ascertained that the many large, important overseas markets established in my research, required greater quantities of Kefir Culture. The huge size of these markets dwarfed the stockpile available, especially after the Kefir Culture was dried.

To support my argument I do furnish the Court with documents simply researched here in India from recent CDRom Encyclopedias and what little Internet Research I could manage here. I also offer as supporting evidence four books, three of which highlight my work in the ever increase ‘field of knowledge’ of the significant benefits of Kefir, it’s [sic] constituent Yeasts and Bacteria.”

No letter dated 13 March 1998 had previously been received by me or the Court as stated by the first respondent in the opening paragraph of this letter. The likelihood is that he intends to refer to the letter of 13 January 1998 to Mr Coburn, a copy of which was forwarded to the Court to my attention. I set out that letter in full, as the first respondent relies upon its contents as a reason for his absence from the jurisdiction :-

“January 13, 1998

Niall Coburn

Principal Lawyer

Market Investigations, ASC

RE: ASC v John Donovan & Julia Donovan Federal Court Proceedings QG 3006 of 1997

Dear Sir

It has just recently come to my attention that the above proceedings have been instigated, regarding my ex wife and me. At this time I have no details and so do not know the specifics of any charges or the intent of your department other than you have certain Affidavits, of which I do not have copies, with which you seek to prove some point of misdeed on our part.

I would certainly like to be in Australia to defend myself in Court if that were possible financially and also practical. Unfortunately it is not. As you must be aware sir, I have no money for such defence. Nor am I inclined to answer charges which have been formulated without my ever being interviewed by your department or given an opportunity prior to this Court appearance to answer questions that could quite possibly have negated the need, at Tax Payers expense, for such proceedings to take place. You are obviously well aware of the malicious extent to which certain ex-employees and a relatively few creditors have waged a campaign to malign my name and bring retribution upon us by any means possible.

I have been threatened with death by at least one of the Creditors, punched in the face by an ex employee and threatened with ruin by others. Malicious rumours have been spread about me and all manner of vile actions directed at me.

I have watched with morbid fascination the legal wrangling by lawyers, Voluntary Administrators, Creditor Committees, Management Consultants and now yourselves as you all seek to justify your own professions, while hundreds of thousands of dollars was taken from our accounts. Each of you in turn manoeuvring [sic] to find the scapegoat, which of course you now determine, is we. Or should I say me.

Are you like the Administrators, pawns to be pushed around by weak minded men who wish not to accept any blame for buying a business which they were well informed about and knew very well carried with it risk. Risk that they were well remunerated for.

I can not be at your Court Hearing. I do not have the money to defend myself, as I would imagine I would have to. Nor sir do I feel that you have brought such proceedings against me from doing due diligence. Rather expediency, propelled and honed by select interests.

Nor sir, do I feel safe in Australia, and certainly not confident of a fair trial knowing now from whom you have gained Affidavits.

Should such proceedings go forward without me and some judgement made without my being able to be there to defend myself, I will seek redress as soon as financially able and practicable.

I will also be contacting the Presiding Judge to make him aware of my feelings and subsequent actions.

I am aware that Julia Donovan has had a Lawyer represent her, but am not in contact with her nor seek to be. We are now divorced and she is her own master. For her part she had little to do with the Company and I can see no value in her prosecution other than as I mentioned, some unholy vengeance.

I am sickened by the Professionals like you and Geroff who allowed yourselves to be manipulated and have in Geroffs instance, been well rewarded at the expense of the Creditors. In my opinion such legal thieving, under the auspices of ‘protection of creditors money’ most certainly helped drive my Company to the wall.

Unfortunately sir I have little respect for any of you, based entirely on my own experience so far. In my humble opinion I can do more good for the Grower/Creditors where I am. That is seeking to finish the job I started. To make Kefir an important export earner for Australia and health product for the world. That Mr Coburn will bring more joy to the Growers than seeking to place me in some ‘sin bin’ for failed businessmen.

Any charges you may have brought against my ex wife and me have little substance without interviewing me before hand. None of those who have sworn Affidavits had the required knowledge to be able to formulate a worthy opinion of our position. My actions were based on my knowledge not someone else’s opinion.

Additionally, several of the people who have given you Affidavits have harboured ill will towards me and sort [sic] to bring me down.

I am not proud of my management skills or the mistakes I made. I am however not guilty of any deception and wish I could turn back the clock so that I had travelled a different route to that of Voluntary Administration.

I do not believe that you have been well guided in your action to pursue us in court and ask you to seriously consider dismissal of the charges.

Go in peace and God help the entrepreneurs in Australia.

John Donovan

C/- PO box 9

SURFERS PARADISE

QLD 4217

Email: ollig@bom2.vsnl.net.in

Cc Mr Justice Cooper”.

The second respondent did not oppose the relief sought in the notice of motion, save that she filed material relevant to her involvement in the management and affairs of Good Life and to any pecuniary penalty the Court may order her to pay.

The case alleged against the respondents

The case alleged against the respondents which the ASC submits entitles it to the relief sought is that pleaded in the statement of claim. The statement of claim, so far as is presently relevant, stated :-

“1. The Good Life Company and Friends Pty Ltd (‘Good Life’):

(a) Was incorporated on 28 April 1992;

(b) Is now and has at all material times been a proprietary company;

(c) On 8 October 1996 appointed Mr Peter Geroff and Mr Gregory Moloney of Ferrier Hodgson (Qld), Chartered Accountants, as administrators pursuant to section 436A of the Corporations Law;

(d) On 9 January 1997 executed a Deed of Company Arrangement in accordance with a resolution of its creditors pursuant to section 439C of the Corporations Law;

(e) On 27 June 1997 went into liquidation in accordance with a resolution of its creditors pursuant to section 445E of the Corporations Law.

2. The Respondents:

(a) were appointed as a directors [sic] of Good Life on 28 April 1992 and remained from that date until 9 January 1997, the only directors of Good Life;

(b) each held beneficially one ordinary share of the two issued ordinary shares in Good Life at all material times.

3. From 2 February 1994 Good Life:

(a) sold growerships and quotas for the production of a fermented milk product known as Kefir for the purposes of:

(i) raising capital, and

(ii) outsourcing the production of Kefir;

(b) had as its principal source of income the proceeds of the sale of quotas for the production of Kefir.

4. Pursuant to contracts used by Good Life to effect the sale of quotas:

(a) the purchaser received certain plant and equipment, know how, a licence to use intellectual property and management support to enable the purchaser to grow Kefir on a commercial basis;

(b) the purchaser paid Good Life a consideration ranging from $700 per quota to $14,900 per quota in the period from 2 February 1994 to 8 October 1996;

(c) Good Life undertook to acquire a certain quantity of Kefir from the purchaser each month, for a consideration, in most cases, of $700 per quota;

(d) the term of most contracts was a period of 5 years.

5. From 2 February 1994 to 8 October 1996 Good Life:

(a) sold 1491 quotas for the production of Kefir to 291 growers;

(b) received $16,429,132 as consideration for the sale of the quotas;

(d) stockpiled approximately 70 tonnes of raw Kefir produced under quotas in either a frozen or freeze dried state;

(e) developed a number of Kefir related products including Kefir making kits in the form of a blister pack, a Kefir jar together with a ceramic pot and Kefir pyramid, and Kefir soap;

(f) spent considerable sums in attending local and international trade shows in order to assist in development and marketing its products;

(g) failed to obtain a market for the Kefir produced under the quotas it had sold.

6. In October 1995 Good Life engaged Paul Mullooly, an accountant, to prepare a report on the company. On 17 November 1995 Paul Mullooly presented a report to the Respondents recommending, inter alia, that the directors:

(a) Seek immediate legal advice before accepting any further monies from the sale of growerships;

(b) Send a notice to holders of quotas advising inter alia:

(i) that until sales of product eventuated, the company could not meet its ongoing monthly commitments;

(ii) that until the likely market demand was known it was not prudent to continue selling further quotas.

7. In June 1996 the Respondents received certain advice from David Millhouse & Associates as to the financial situation of Good Life:

(a) on 21 June 1996 the Respondents received advice from David Millhouse and Associates that Good Life may be trading when it is technically insolvent.

(b) On 27 June 1996, David Millhouse provided Good Life with an Operating Memorandum 381/2 which, inter alia, specified that Good Life seek protection in whole or in part from further payments to growers; should immediately cease a new grower recruitment; and needed urgently to generate real sales revenue.

8. On 9 August 1996 the Respondents received advice from P G Downie, Chartered Accountants to, inter alia, the following effect:

(a) that whatever rate of sales of growerships was achieved, the associated outgoings would eventually exceed the company’s income;

(b) that under the provisions of section 232 of the Corporations Law the directors of a company had a clear responsibility to ensure care and diligence in the performance of their duties;

(c) that unless Good Life was able to establish immediately a market for the product to provide adequate funds to buy back a significant portion of quotes, the company must enter into a form of administration.

9. Notwithstanding the views expressed in the report to the Respondents from Paul Mullooly, from December 1995 onwards Good Life made 158 contracts for the sale of growerships with third parties and received a consideration of approximately $14,782,111.

10. Notwithstanding the views expressed in the letters to the Respondents from David Millhouse and Associates and P G Downie, from 5 July 1996 to 8 October 1996 Good Life made 63 contracts for the sale of growerships with third parties and received as consideration $3,530,600.

11. As a result of Good Life continuing to enter into contracts with growers, Good Life incurred a contingent liability under the contracts of sale of quotas to growers made between 2 February 1994 and 8 October 1996 of approximately $53,000,000.

12. By virtue of paragraphs 6, 7 and 8, the Respondents knew or ought to have known that they should not have entered into further contracts with growers in the absence of securing either local or international market for the sale of the product.

13. The Respondents knew or ought reasonably to have known that good Life from the commencement of trading on 2 February 1994 to the appointment of the voluntary administrator on 8 October 1996 was incurring debts in such a manner that it would be unable to meet them as and when they fell due.

14. The Respondents failed to prevent Good Life from incurring debts at times when it was unable to meet its debts as and when they fell due, and/or failed to acknowledge to growers at any time after 17 November 1995 that payments to growers would exceed the inflow generated by sales of growerships.

15. The Respondents knew or ought reasonably to have known that the majority of parties who purchased quotas to grow Kefir:

(a) were not sophisticated investors;

(b) borrowed substantial sums on the basis that they were investing in an activity that would ensure a source of future income.

16. In the premises, each of the First and Second Respondents in the exercise of their powers and discharge of their duties as directors of Good Life from 2 February 1994 to 8 October 1996 failed to exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation’s circumstances, in contravention of subsection 232(4) of the Corporations Law.

17. For the purposes of subsection 1317EA(5), the failure of each of the Respondents to exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation’s circumstances, constituted a serious contravention of a civil penalty provision.”

The ASC filed a number of affidavits and exhibited considerable documentation to prove up each of the allegations contained in paragraphs 1 to 11 inclusive and paragraph 14 of the statement of claim. The matters pleaded in paragraphs 12, 13 and 15 arise by way of inference from the affidavit material and the matters in paragraphs 16 and 17 are conclusions of law or mixed law and fact.

I am satisfied that matters pleaded in paragraphs 1 to 8 inclusive and paragraphs 10, 11 and 14 are made out on the material. I have considered the allegation of the first respondent that some of the affidavit material comes from persons who have ill-will towards him. However, the advice given to him is substantially in written form and it is corroborated by the investigations of Mr Peter Geroff, the administrator and later liquidator of Good Life. The majority of these allegations are matters of objective fact, and nothing said by the first respondent indicates that the allegations are other than correct.

The allegation in paragraph 9 is not made out on the material. The sales of growerships for the financial year ended 30 June 1996 was $8,914,990. The sales for the period 1 July 1996 to 8 October 1996 totalled $5,867,121 which included grower equipment sales of $2,133,046. The combined total for the two periods is $14,782,111, the amount pleaded in paragraph 9. However there is nothing to which I was referred or could find which would limit the sales to the period December 1995 to 8 October 1996. Nevertheless, it is clear from the affidavit of Mr Geroff and the exhibits to it, that in the period of approximately three months to 8 October 1996 approximately twenty-two percent of the total 291 growerships were sold. The consideration received for them represented approximately forty percent of the total receipts from growers for the purchase of growerships including associated goods, services and grower equipment.

What also is apparent from the affidavit material is the movement in the price charged by Good Life for each quota sold to a grower who acquired a “growership” in the period June 1995 to October 1996. In June 1995 Good Life charged $9,800 per quota. That rose to $10,900 by March 1996, to $12,500 on 14 April 1996, to $13,900 on 10 June 1996, and to $14,900 on 20 September 1996. Indeed, at the end of this period the first respondent had under consideration raising the price per quota to $20,000.

The central allegation of the ASC is that the respondents received a number of warnings concerning the impending insolvency of Good Life and the lack of a market in which to sell the Kefir products, and despite this, Good Life continued to sell growerships, failed to acknowledge the financial state of Good Life and caused Good Life to incur debts in circumstances where it would not be able to meet those debts as and when they fell due. These are the matters pleaded in paragraphs 6, 7, 8 and 14 and underpin the allegations pleaded in paragraphs 12, 13, 16 and 17 of the statement of claim.

The material reveals that those warnings took a number of forms, and included expressions of concern from employees of Good Life.

Paul Mullooly was an accountant employed by Good Life. Mr Mullooly’s concerns, expressed in a report dated 17 November 1995, caused him to resign after only four weeks employment. The report stated, in part :-

“3) Market Research

No formal market research has been carried out either within Australia or overseas. Therefore any projections of likely Sales demand is at best a guess. There is a lack of any real understanding within the Company of the need for this type of research and a corresponding misunderstanding of how a new product’s life cycle actually evolves.

4) Cash Flow

The projected cash flow indicates that there is every expectation that a serious cash crisis will occur well in advance of any significant sales volumes occurring.

.....

7) Sale of Growerships

I am not fully conversant with Australian Companies Legislation, however I cannot help but wonder if there is any breach of the Corporations Law in selling Growerships in the way that you are. There may be a very real risk at this point of you being in contravention of Section 52 of the Trade Practices Act. I therefore advise that as Directors you seek immediate legal advice before you accept any further monies from the Sale of Gorwerships [sic].

8) Solvency

A company is insolvent when it has insufficient assets to meet its liabilities. Whilst the Goodlife [sic] Company in fact has a positive Bank Balance at this time, I cannot be sure that it passes the test of solvency given how the business is being funded.

As I see the situation right now, unless and until evidence becomes available that the business will generate sufficient revenue from sales of product, you must act as if the Company is insolvent. In this situation, you as Directors of the Company have an obligation to comply with Companies Law as it applies to such a situation. I strongly urge you to seek immediate legal advice on this matter.

9) Growers

I believe that you have an obligation to the Growers to appraise them of the current situation, and I have attached a brief ‘Draft Notice to Growers’ which I think you should present to a meeting of Growers.

10) Cash demands

The business at this point in time has a monthly cash outflow of approximately $400,000. To service this level of out flow, you need sales of approximately 200,000 units (bugs) per month. Therefore the Japanese market would need to be capable of consuming this level of sales each month.

However as I have pointed out (under section 5 Japanese Market), it is unlikely that any orders will be realised from that market before end March 1996. Therefore you have a period of four and a half months where you cannot meet the monthly cash demands. This shortfall should not be met through the sale of Growerships until you have taken legal advice on the question of the sale of Growerships.

I recommend that you take immediate legal advice as to your responsibilities as Directors. I also recommend that you endeavour to ascertain from Japan what the likely sales demand will be and when it is likely to commence. You need this information so that you can decide exactly what course of action you must take next.

I personally do not wish to continue my involvement with the Company and attach the appropriate letter dealing with this decision.”

Neil Paulsen, an employee salesman from June 1995 to March 1996, deposes to a conversation with the first respondent shortly before a trade fair in Anaheim, USA in March 1996 :-

“NP ‘If we don’t achieve a seriously big contract I am going to resign. Good Life can’t go on selling quotas to growers if it doesn’t have a market for the Kefir they produce. At this rate, the only way Good Life will be able to pay the growers for the Kefir is by selling more quotas to other growers and I’m concerned that some of the growers I’m selling quotas to now won’t be paid’.

JD ‘I am stunned. How can you possibly not believe that I can achieve the result?’

Julia Donovan was also at the meeting together with Wayne Donovan, the official photographer for Good Life and the person who established Good Life’s web site.”

He also deposes to the following conversation at the trade fair :-

“NP ‘I don’t believe your predictions and I think you’ve been stringing me along. My conscience won’t let me keep selling quotas to produce Kefir when I know that the only way Good Life can pay for the Kefir is by selling more and more quotas to grow it, and building up more and more debt to growers. I’m resigning.’”

Paul Kinash, an accountant employed by Good Life between December 1995 and October 1996, had expressed similar views to the first respondent in January 1996.

In or about May 1996, Good Life engaged the services of David Millhouse & Associates Pty Ltd, a company that provides advice on “corporate strategy, business planning, investment banking and corporate governance”. On 21 June 1996 David Millhouse & Associates wrote to the respondents as follows :-

“Dear John and Julia

We have to date undertaken an analysis of Goodlife [sic] Company and Friends Pty Ltd to enable us to develop a comprehensive Business Plan. As is normal with a business planning assignment, we commence with an organisational audit and market analysis followed by an analysis of the financial resources required.

We think that the Goodlife [sic] business has vision and opportunity. However, DMA is of the view that the company may be trading when it is technically insolvent. The Directors will be personally liable for any liabilities incurred whilst trading when insolvent.

We are preparing a brief for you for submissions to suitably qualified legal and accounting professionals. Their response may confirm or otherwise our analysis.

This conclusion has been reached on the basis that we believe the taxation treatment of grower payments and the nature of the liability to the growers in respect of future payments is not reflected in the accounting or other financial statements of the company.

We urge you as Directors to act on these concerns immediately on your return.

Please contact me to discuss this matter further and talk through these issues.”

David Millhouse deposes to further advice he gave the respondents on 27 June 1996 :-

“On or about 27 June 1996 I provided to John and Julia Donovan a further memorandum, a copy of which is annexed hereto and marked ‘DMA6’. In it I set out my concern that the company was technically insolvent. I pointed out that grower contract cash inflows were being treated as sales receipts, owing [sic] a distorted picture of the company’s true situation, with profitability overstated and non-current liabilities grossly understated. I advised that the company should, among other things, immediately cease new grower recruitment, seek protection in respect of further payments to growers and that it needed urgently to generate real sales revenue.”

The further memorandum referred to by Mr Millhouse stated, in part :-

“In our view, the GLCF [Good Life] is technically insolvent, although it has substantial positive cash flows at present. These cash inflows will shortly generate substantial cash outflows larger than the inflow. The pro-forma Balance Sheet below illustrates why we are of this view.

Since this was created, we are informed that there have been additional quotas sold creating extra liability under contract of A$10 million for grower quotas placed pursuant to the contracts analysed by us and which are in question for capital taxation and commercial purposes.

This Memorandum uses information provided by officers of the GLCF and we cannot warrant the accuracy of it.

Role of the directors

The directors have a duty to the company, its creditors, and any other party materially associated with it. These duties are derived from several sources of law, but in particular, if the directors are of the view that the GLCF cannot pay its debts when they fall due, then they are obliged to cease operations.

Under the present contracts with growers, and in the absence of cash inflows from other sources, this appears to be the circumstance in which the directors find themselves.

Accounting statements

The accounting statements provided to us, albeit in draft form, do not appear to reflect a true and accurate representation of the financial condition of the GLCF.

In part, this is caused by the uncertainty in respect of the financial accounting and tax treatment of grower quota payments, but more particularly, it is due to non-recognition in the Profit and Loss and Balance Sheet of the liability to grower payments in the future.

The directors should not sign the accounts dated 30 June 1995 as made available to us.

Accrual accounting requires that provision be made in the P/L account for the cost of storage and depreciation in value (if any) of the kefir stockpile, and that the current and non-current liability of future contracted payments to growers be disclosed in the Balance Sheet. At present, they are off Balance Sheet except as prepaid management fees.

At present, the accounts are presented largely on a cash basis and treat the grower contract cash inflows as sales receipts.

This presentation distorts the true nature of the GLCF profitability and shareholder equity in favour of the company. In fact, it is probably true to say that the company is neither profitable nor does it have any shareholder equity. In fact, it overstates its profits (depending in part on opinion of the nature of the grower contracts) and grossly understates its non-current liabilities.

There is no evidence to suggest that this is deliberate policy or is an attempt to be misleading. However, de facto these are the facts.

The presence of strong positive cash flows does nothing to change these facts and indeed unless there is continued exponential growth in new grower quotas, the cash flows will become negative. We are trying to determine when this will occur.

Even if GLCF continued to rely on new grower quotas for funds, at some point, the price of the quotas will fall and there may be no additional market for them.”

The pro forma balance sheet prepared by Mr Millhouse estimated net assets of Good Life at negative $7,031,994.43 primarily due to what it describes as “grower payments contracted future periods”. Mr Millhouse also swears that he advised the first respondent on a number of occasions that he should cease selling quota. The advice from Mr Millhouse continued in the context of developing a business plan for Good Life. In a memorandum dated 9 September 1996 to Good Life, Mr Millhouse again alludes to insolvency by stating that Good Life “has been advised that it is close to insolvency”.

Mr Millhouse also swears to a meeting with the respondents at the respondents’ home in September 1996, at which Mr Millhouse “indicated to them that they had no choice but to put the company into administration or liquidation”. Mr Millhouse also deposes to conversations he had with the first respondent at a growers’ meeting at Bond University in September 1996 at which he told the first respondent to cease selling quota. Mr Millhouse also says he advised the first respondent that Good Life would run out of money by November or December 1996.

The professional external advice the respondents received was not confined to that from Mr Millhouse. In August 1996 Good Life received advice from P G Downie Chartered Accountants. Prior to the delivery of the report, Mr Downie and Ms Susan Carter from that firm held a meeting with the respondents. Mr Downie swears to the following conversation with which Ms Carter agrees :-

“3. .....

GD [Graham Downie] ‘We can’t emphasise enough that unless the company changes direction immediately there is no alternative to some form of administration, possibly liquidation. Is there anything you don’t understand about the alternative of voluntary administration?’

JD [John Donovan] ‘No, I understand how voluntary administration could be an option, but I’m confident that it isn’t necessary’.

DK [David Kerr] ‘There is no doubt that the company should stop selling quotas’.

SC [Susan Carter] ‘You can see that at the present rate of quota sales you only have until March 1997 when payments to growers will be greater than your income from the sale of quotas’.

JD ‘Can you give us an idea of what difference it would make if the price of quotas was $20,000?’

SC ‘If you want me to I can modify the model to reflect that price’.

JD ‘I hear what you say about what our options are, but just now I want to focus on marketing the Kefir in the United States by way of an ‘infomercial’. I am confident that sale of the product using that technique will produce huge returns for the company, and I’m confident we can product it and have it screening within three months’.

Julia D [Julia Donovan] ‘I want to focus on how the infomercial can help us right now’.

SC ‘I’d need some more details to be able to assess the effect of your infomercial on the financial models, for instance what it will cost and what sales you expect it to achieve’.

Julia D ‘Come and see me when you know exactly what it is you need and I’ll see that you get it’.”

The written advice from Mr Downie, dated 9 August 1996 stated, in part :-

“(i) Continued Sale of Quotas

The cash in-flow required to meet the commitments to growers under the existing contracts is approaching $1m per month. Susan Carter’s discussions with your Mr Kevin Biddle suggest that the sale of 100 growerships per month is achievable, although only 64 were sold in the month of July, 1996. Our viewgraph, A1, indicates that at the selling price of $13,900 per quota, the payments to growers will exceed the inflow generated by sales of growerships by March 1997. Following our meeting with you on Monday 5 August 1996, at your request we have modified the model to reflect a sale price of $20,000 per growership. Those results are produced at viewgraph A2, which indicates that the payments still reach a point of exceeding sales, but not until November 1997. Viewgraph A3 demonstrates that if quota sales are stopped, the company’s resources will be sufficient to enable grower payments for another 3 months only until October 1996. In completing these viewgraphs we have not taken to account the potential liability for income tax and stamp duty.

.....

Alternatives

The company is at present meeting its debts as they fall due but it is quite apparent from the viewgraphs that it does not matter what rate of sales of growerships is achieved the associated outgoings will eventually exceed the company’s income. Under the provision of section 232 of the Corporations Law the directors of a company have a clear responsibility to ensure care and diligence in the performance of their duties.

In our opinion unless you are able to establish immediately a market for the product to provide adequate funds to buy-back a significant portion of quotas the company must by necessity enter into a form of administration. The purpose of this is to bring its affairs to order for the protection of creditors, the protection of growers and to provide the moratorium period necessary to allow the company to re-structure its affairs and to direct its resources into the development of markets for its products. ....”

The advice then discussed the options of voluntary administration leading to a deed of company arrangement or liquidation. The conclusions of Mr Downie were :-

“Conclusion

You have indicated your confidence that the sale of the company’s product in the United States by use of infomercial techniques will produce a substantial return to the company. You have also indicated that the production of a commercial and its screening can be achieved within a three month period.

Our advice is that you must seek a report on your proposed course of action from a recognised US firm of marketing consultants indicating whether or not your proposal is viable and the extent of the likely return to the company. This report should be sought as a matter or [sic] urgency.

Should the report indicate that the marketing strategy will provide returns to the company quickly enough and significant enough to buy back a large proportion of quotas then you should proceed with the infomercial.

If the report does not support these expectations then we consider that the directors have a duty to place the control of the company in the hands of an external administrator.”

It is clear on the material, in my view, that the respondents from at least November 1995 when they received the advice of Mr Mullooly, were aware of the precarious financial state of Good Life and that continuing to fund grower payments by sale of more growerships without any significant sale of its product, would lead to a serious cash crisis and insolvency. That this was the case was reinforced by the advice of Mr Millhouse in the period June 1996 to September 1996. In addition, the advice of Mr Downie in August 1996 could only have served to heighten the concerns of Good Life and the respondents.

It is equally clear that at no stage did a market for Good Life’s products emerge. As at 8 October 1996 Good Life had sold only $64,927 of Kefir products and $97,626 of Kefir soap. The material also reveals that marketing attempts by the administrator of the products and of the business itself have also been unsuccessful. The liquidator was also unsuccessful in his attempts to sell the business. On 23 September 1997 the liquidator auctioned the assets of Good Life. Most of the assets of Good Life were sold, realising $280,142 before expenses.

No dividend will be paid to creditors.

The allegation in paragraph 15 of the statement of claim is not made out. At the highest the material shows the sale of growerships was marketed in regional areas by word of mouth or by newspaper advertisements. It was directed to rural producers and retirees as a home based business to generate guaranteed additional income.

Duty of care and s232(4) of the Law

The statutory duty of care of officers of a corporation is expressed in s232(4) of the Law, which provides :-

“(4) In the exercise of his or her powers and the discharge of his or her duties, an officer of a corporation must exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation’s circumstances.”

This section, as it currently stands, was inserted by the Corporate Law Reform Act 1992. The Explanatory Memorandum to the Corporate Law Reform Bill 1992 stated (at p 25) :-

“82. Subsection 232(4) currently provides that an officer of a corporation shall at all times exercise a reasonable degree of care and diligence in the exercise of his or her powers and the discharge of his or her duties. Clause 11 amends subsection 232(4) to reinforce that the duty of care is an objective one, requiring a company officer to exercise the degree of care and diligence that a reasonable person in a like position as an officer of a corporation would exercise in the corporation’s circumstances.

83. The Government considers that proposed subsection (4) does not change the law, but merely confirms the present position expounded in recent decisions such as: Hussein v Good (1990) 8 ACLC 390; Heide Pty Ltd v Lester (1990) 8 ACLC 958; Statewide Tobacco Services Ltd v Morley (1990) 8 ACLC 827; Commonwealth Bank of Australia v Freidrich (1991) 9 ACLC 946; AWA Ltd v Daniels (1992) 10 ACLC 933.

84. The inclusion of the expression ‘a reasonable person’ is intended to confirm that the required standard of care and diligence is to be determined objectively.

85. The proposed new subsection obliges a Court to place the reasonable person ‘in a like position’ with the relevant officer. Australian law recognises that the special background, qualifications and management responsibilities of the particular officer may be relevant in evaluating his or her compliance with the standard of care. At the same time, Australian law also recognises that decisions must be made on the basis of the circumstances at the time and without the benefit of hindsight.

86. The proposed new subsection 232(4) also obliges the Court to place the reasonable person in the position of an officer ‘in the corporation’s circumstances’. Thus, the proposed subsection 232(4) will recognise that what constitutes the proper performance of the duties of a director of a particular corporation will be influenced by matter such as the state of the corporation’s financial affairs, the size and nature of the corporation, the urgency and magnitude of any problem, the provisions of the corporation’s constitution, and the composition of its Board.”

An “officer” for the purposes of s232 of the Law is defined in s232(1). It includes a director, secretary or executive officer of the corporation: s232(1)(a). The respondents, at all material times, were officers of Good Life.

The common law duty of care owed by directors to a corporation was considered by the Court of Appeal of New South Wales in Daniels v Anderson [1995] 37 NSWLR 438. The majority (Clarke and Sheller JJA), in a joint judgment, were of the opinion that what the Law required of directors in Australia was the same as that required in the United States. The American position, in their Honours’ opinion, found proper expression in the judgment of Pollock J, giving the opinion of the Supreme Court of New Jersey in Francis v United Jersey Bank 432 A 2d 814 (NJ 1981): 37 NSWLR at 503.

In Francis, Pollock J said (at 821 - 823) :-

“As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged: Campbell v Watson 62 NJ Eq at 416, 50 A 120. Because directors are bound to exercise ordinary care, they cannot set up as a defense lack of the knowledge needed to exercise the requisite degree of care. If one ‘feels that he has not had sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act’.

Directors are under a continuing obligation to keep informed about the activities of the corporation. Otherwise, they may not be able to participate in the overall management of corporate affairs. Barnes v Andrews 298 F 614 (SDNY 1924) (director guilty of misprision of office for not keeping himself informed about the details of corporate business); Atherton v Anderson 99 F 2d 883, 889 - 890 (6 Cir 1938) (ignorance no defense to director liability because of director’s ‘duty to know the facts’); Campbell at 409, 50 A 120 (directors ‘bound to acquaint themselves with ... extent ... of supervision exercised by officers’); Williams v McKay 46 NJ Eq 25, 36, 18 A 824 (Ch 1889) (director under duty to supervise managers and practices to determine whether business methods were safe and proper). Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. The sentinel asleep at his post contributes nothing to the enterprise he is charged to protect: Wilkinson v Dodd 42 NJ Eq 234, 245, 7 A 327 (Ch 1886), affirmed 42 NJ Eq 647, 9 A 685 (E & A 1887).

Directorial management does not require a detailed inspection of day-to-day activities, but rather a general monitoring of corporate affairs and policies. Williams v McKay at 37,k 18 A 824. Accordingly, a director is well advised to attend board meetings regularly. ...

While directors are not required to audit corporate books, they should maintain familiarity with the financial status of the corporation by a regular review of financial statements. ...

The review of financial statements, however, may give rise to a duty to inquire further into matters revealed by those statements. Corsicana Nat’l Bank v Johnson 251 US 68, 71; 40 S Ct 82, 84; 64 L Ed 141 (1919); Atherton 99 F 2d at 890; LaMonte v Mott 93 NJ Eq 229, 239 107 A 462 (E & A 1921); see Lippitt v Ashley 89 Conn at 457, 94 A at 998. Upon discovery of an illegal course of action, a director has a duty to object and, if the corporation does not correct the conduct, resign. See Dodd v Wilkinson 42 NJ Eq 647, 651, 9 A 685 (E & A 1887); Williams v Riley 34 NJ Eq 398, 401 (Ch 1881) ...

A director is not an ornament, but an essential component of corporate governance. Consequently, a director cannot protect himself behind a paper shield bearing the motto ‘dummy director’: Campbell at 443, 50 A 120. (The directors were not intended to be mere figure-heads without duty or responsibility); Williams v McKay at 57 - 8, 18 A 824 (director voluntarily assuming position also assumes duties of ordinary care, skill and judgment). The New Jersey Business Corporation Act, in imposing a standard of ordinary care on all directors, confirms that dummy, figurehead and accommodation directors are anachronisms with no place in New Jersey law. See NJSA 14A: 6-14. Similarly, in interpreting s 717, the New York courts have not exonerated a director who acts as an ‘accommodation’.”

Their Honours, in Daniels, continued (at 505) :-

“We are of the opinion that a director owes to the company a duty to take reasonable care in the performance of the office. As the law of negligence has developed no satisfactory policy ground survives for excluding directors from the general requirement that they exercise reasonable care in the performance of their office. A director’s fiduciary obligations do not preclude the common law duty of care. Modern statutory company law points to the existence of the duty. In some circumstances the duty will require action. The concept of a sleeping or passive director has not survived and is inconsistent with the requirements of current company legislation such as, at the relevant time, ss229 and 269 of the Code. The duties imposed upon directors by virtue of s 556 have already been discussed.

A person who accepts the office of director of a particular company undertakes the responsibility of ensuring that he or she understands the nature of the duty a director is called upon to perform. That duty will vary according to the size and business of the particular company and the experience or skills that the director held himself or herself out to have in support of appointment to the office. None of this is novel. It turns upon the natural expectations and reliance placed by shareholders on the experience and skill of a particular director. The duty is a common law duty to take reasonable care owed severally by persons who are fiduciary agents bound not to exercise the powers conferred upon them for private purpose or for any purpose foreign to the power and placed, in the words of Ford and Austin, Principles of Corporations Law, 6th ed at 429, at the apex of the structure of direction and management. The duty includes that of acting collectively to manage the company. Breach of duty will found an action for negligence at the suite of the company.”

This statement of the standard of care was applied by Derrington J in Re Property Force Consultancy Pty Ltd (In Liq) [1997] 1 Qd R 300, a case which dealt with alleged breaches of duty under s232(4) of the Law.

The relevant statute under consideration in Francis required directors to “discharge their duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise in similar circumstances in like positions.” Neither s232(4) of the Law, nor its predecessor s229(2) of the Companies (Qld) Code, make reference to the requirement of skill. This omission was noted by the majority in Daniels (at 503) and by Malcolm CJ as a member of the Full Court of Western Australia in Vrisakis v Australian Securities Commission (1993) 9 WAR 395 at 407. However, it was accepted that the duties the section imposed reflected the general concept of negligence at common law which included skill as an element. In Daniels, their Honours concluded (at 504 - 505) :-

“Although there was no reference to skill in s 229(2) of the Code - nor is there in s 232(4) of the Corporations Law -, Malcolm CJ in Vrisakis at [407] thought that the duties imposed by the section reflected the general concept of negligence at common law. This means conduct ordinarily measured by reference to what the reasonable man of ordinary prudence would do in the circumstances. Skill is that special competence which is not part of the ordinary equipment of the reasonable man but the result of aptitude developed by special training and experience which requires those who undertake work calling for special skill not only to exercise reasonable care but measure up to the standard of proficiency that can be expected from persons undertaking such work: Voli v Inglewood Shire Council at 84 per Windeyer J. A director may be appointed because of a particular or special skill and may take up the appointment on the basis that he or she will bring that skill to the performance of the office. In Gould v Mount Oxide Mines Ltd (in liq) (1916) 22 CLR 490 at 531 Isaacs and Rich JJ said:

No rule of universal application can be formulated as to a director’s obligation in all circumstances. The extent of his duty must depend on the particular function he is performing, the circumstances of the specific case and the terms on which he has undertaken to act as a director.”

Did the respondents breach the duty imposed by s232(4) of the Law?

The conduct which the ASC alleges as being in breach of the duty owed under s232(4) of the Law was causing or permitting Good Life to continue between October 1995 and October 1996, to sell growerships and quota to growers of Kefir in the absence of any market for the product and in disregard of contrary expert advice, as appears from paragraph 12 of the statement of claim and paragraph 1 of the prayer for relief.

The report of Mr Mullooly of November 1995 put the directors of Good Life on notice that there was then no established market in which the company was selling or able to sell Kefir purchased from growers to whom growerships and quota had been sold by the company, and that no formal market research had been carried out in Australia or overseas to identify such a market. The report also put the directors on notice that the projected cash flows indicated a serious cash crisis before any significant sales volumes of Kefir could be achieved by Good Life. It was also apparent from the report that the cash demands of Good Life were being funded by the sale of growerships and quota and not from the sale of Kefir which continued to be stockpiled in storage. Similarly, the obligation to pay for Kefir produced by the growers involved a demand for cash which could only be met from cash receipts from the sale of growerships and quota. The greater the number of growerships and quota sold, the greater the need for cash to pay for the obligations undertaken to purchase and pay for Kefir produced under the quota. That the directors knew, or should have known, that there was a growing need to generate cash to discharge the obligations incurred by the sales of growerships and quota, is demonstrable by the upward movement in the price charged for a quota in the period June 1995 to September 1996, and the specific request of Mr Downie in August 1996 to investigate whether sales of 100 growerships per month with a price of $20,000 would overcome the cash flow crisis of Good Life.

Put simply, Good Life was selling growerships and quota for substantial sums in order that the growers would produce a product for which there was then no market. The only purchaser for the product was Good Life and it could only finance the purchase of the product from selling more growerships and quota because there was no established market for the product. Absent the establishment of an immediate real market for the product, Good Life was embarked upon a course which would lead to its insolvency because it was taking on financial obligations to purchase product which it ultimately would not be able to discharge. Advice to this general effect was given to at least the first respondent in November 1995 by Mr Mullooly, in March 1996 by Mr Paulsen, in June 1996 by Mr Millhouse and in August and September 1996 by Ms Carter and Mr Downie.

The course of conduct embarked upon and persevered in, despite the advice given, carried the real risk of loss and damage. It was a risk which affected the persons purchasing growerships and quota, the company itself, and the creditors. It was a risk which ultimately materialised. For those growers who were not able to sell product to Good Life or who were not paid for product sold because Good Life did not have a market for the product and ran out of funds to pay for product, the investment in growerships and quota was lost. For the company, absent a real market for the Kefir, the company stockpiled a worthless product and incurred costs and expenses in doing so. Additionally, the company accrued additional debt which it was unable to pay.

Objectively, no person in the position of the respondents, with the knowledge the first respondent had and which the second respondent should have had, acting reasonably and exercising care and diligence, would have continued after November 1995 selling growerships and quota to potential growers of Kefir. There was not at that time, nor thereafter, any reasonable basis to reject the professional advice which was being tendered. Nor was there any reason in fact to believe that a sufficient market for Kefir would be established in a time frame and with sufficient demand for product, as would enable the company to dispose of the stockpile which it then held and to discharge its obligations to growers for future purchases.

Although the respondents are in default in filing defences, I have carefully read all of the material sent by the first respondent to the Court as his defence to determine whether or not any ground of defence is disclosed. In my view there is nothing in the material which makes the conduct of the directors, in allowing the company to continue to sell growerships and quota contrary to the expert advice which the company received, either reasonable or rational or conduct which satisfied the duty of care provided for in s232(4) of the Law.

It is not sufficient that the product may have beneficial characteristics useful to good health and capable of being used in the prevention or treatment of disease. All of the material put forward by the first respondent goes to a submission that there should be, or may well be, a commercial market for the product of some significance in the future. However, the material does not disclose that there was any commercial market existing during the relevant time or that the respondents had any reasonable reason to believe that the creation of one was imminent. Absent a commercial market, to continue to sell growerships and quota was conduct in breach of the duty of care required by s232(4) of the Law to be discharged by the respondents.

The ASC therefore makes out a contravention of s232(4) of the Law as alleged in paragraph 16 of the statement of claim, although it does not make out a continuing breach between 2 February 1994 and 8 October 1996, if that is the intent of the pleading in paragraph 16. The relevant period of the breach made out on the statement of claim is the period November 1995 to 8 October 1996.

The consequence of a breach of s232(4) of the Law

The pleading in paragraph 17 of the statement of claim requires a consideration of s1317EA of the Law. That section provides :-

“1317EA(1) This section applies if the Court is satisfied that a person has contravened a civil penalty provision, whether or not the contravention also constitutes an offence because of section 1317FA.

(2) The Court is to declare that the person has, by a specified act or omission, contravened that provision in relation to a specified corporation, but need not so declare if such a declaration is already in force under Division 4.

(3) The Court may also make against the person either or both of the following orders in relation to the contravention:

(a) an order prohibiting the person, for such period as is specified in the order, from managing a corporation;

(b) an order that the person pay to the Commonwealth a pecuniary penalty of an amount so specified that does not exceed 2,000 penalty units.

(4) The Court is not to make an order under paragraph (3)(a) if it is satisfied that, despite the contravention, the person is a fit and proper person to manage a corporation.

(5) The Court is not to make an order under paragraph (3)(b) unless it is satisfied that the contravention is a serious one.

(6) The Court is not to make an order under paragraph(3)(b) if it is satisfied that an Australian court has ordered the person to pay damages in the nature of punitive damages because of the act or omission constituting the contravention.

(7) Section 91A defines what, for the purposes of this section, constitutes managing a corporation.”

Section 232(4) of the Law is a civil penalty provision: s1317DA. A breach of the duty imposed by s232(4) of the Law is a contravention of a civil penalty provision for the purposes of s1317EA.

The ASC is a proper applicant for a civil penalty: s1317EB(1)(a). The application has been brought within six years of the contravention of s232(4) of the Law as required by s1317EC.

The ASC is therefore, on the pleadings and the material relied upon to make out the allegations pleaded, entitled to a declaration under s1317EA (2).

The ASC submits that in the circumstances of this case orders should be made under s1317EA(3)(a) prohibiting the first respondent from being involved in the management of a corporation for life and that the second respondent should be prohibited from being involved in the management of a corporation for ten years.

Section 1317E(3)(a) is a protective provision designed to protect the public and to prevent a corporate structure being used by individuals in a manner which is contrary to proper commercial standards. In Re Tasmanian Spastics Association; ASC v Nandan (1997) 23 ACSR 743, Merkel J said (at 751) :-

“... The object of s1317EA(3)(a) is to protect the public by preventing a corporate structure from being able to be misused to the detriment of the company, its shareholders, creditors, investors and others dealing with the company. That objective is confirmed by s1317EA(4) which provides that a court is not to make a prohibition order under s1317EA(3)(a) if it is satisfied that despite the contravention, the person is a fit and proper person to manage a corporation. The objective is achieved by the court being conferred with power to prohibit persons who have contravened a civil penalty provision from managing a corporation for a specified period unless the court is satisfied that the person is a fit and proper person to manage a corporation.”

The protective nature of the provision was also expressed in the Corporate Law Reform Bill 1992 - Public Exposure Draft and Explanatory Paper (paragraph 178) :-

“178. It is expected that in settling an appropriate order, the Court would first give consideration to whether it should impose a civil penalty disqualification. The issue should be whether the defendant’s conduct, whilst not criminal in nature, was so reprehensible and had such serious consequences as to warrant an order prohibiting the person from managing a corporation. For example, if gross negligence by a director had led directly to massive losses for shareholders, the Court may consider that a director should be disqualified for a substantial period, even where there was no question of a dishonest intent. The emphasis should be on preventing a recurrence of the contravention by the defendant, and providing a deterrent to other persons involved in the management of corporations. It is expected that the Courts would consider imposing a pecuniary penalty only if it considered that a civil penalty disqualification provided an inadequate or inappropriate remedy.”

In Nicholas v Corporate Affairs Commission (1987) 5 ACLC 258, O’Bryan J said of s562A(3) of the then Companies (Victoria) Code which empowered the National Companies and Securities Commission to prohibit a person in the circumstances prescribed in the section from being a director, promoter or taking part in the management of a corporation (at 265 - 266) :-

“Section 562A is concerned with a person’s fitness to be a director or promoter of a corporation or to be in any way, directly or indirectly, concerned in or taking part in the management of a corporation (subsec (3)). This concern is for the present and future protection of the public, to protect the public from persons whose past conduct in relation to a dissolved company has been reported on adversely by the liquidator.

The amending section is clearly concerned with present fitness. To determine present fitness necessarily requires one to have regard to past facts. Not surprisingly, therefore, the legislature has prescribed past facts as relevant criteria.

.....

I am of the opinion that sec 562A was inserted to protect the public presently and in the future from persons whose recent past conduct indicates a present lack of fitness to direct, promote or manage a corporation.”

(See also on appeal (1987) 5 ACLC 673 at 681; Friend v Corporate Affairs Commission (1989) 7 ACLC 106 at 115).

In my opinion these observations are equally apposite to s1317EA(3)(a) of the Law.

The material provided by the first respondent as to his attitude to these proceedings and the failure of Good Life is a matter of serious concern. In the letter of 13 January 1998 to Mr Coburn he made the following statements :-

“I have watched with morbid fascination the legal wrangling by lawyers, Voluntary Administrators, Creditor Committees, Management Consultants and now yourselves as you all seek to justify your own professions, while hundreds of thousands of dollars was taken from our accounts. Each of you in turn manoeuvring [sic] to find the scapegoat, which of course you now determine, is we. Or should I say me.

.....

Unfortunately sir I have little respect for any of you, based entirely on my own experience so far. In my humble opinion I can do more good for the Grower/Creditors where I am. That is seeking to finish the job I started. To make Kefir an important expert earner for Australia and health product for the world. That Mr Coburn will bring more joy to the Growers than seeking to place me in some ‘sin bin’ for failed businessmen.

Additionally, several of the people who have given you Affidavits have harboured ill will towards me and sort [sic] to bring me down.

In his letter of 3 March 1998 to the Court he said, in part :-

“That the failure of the Company was not a forgone [sic] conclusion reached previously and based on limited accounting opinion. The failure had more to do with the decision to go into Voluntary Administration which stemmed from the incorrect tax accounting of the consultant accountant recommended by our Management consultant and poor accounting by our own company accountant. It also had more to do with the malicious, unscrupulous nature of The Creditors Committee, who lead a small band of desparate [sic] and angry Grower Creditors right down the road to control of the Company and subsequent bankruptcy.

These statements indicate that the first respondent does not accept any responsibility for what has occurred to Good Life or to those who dealt with it. Nor does he accept that voluntary administration was the inevitable result of the course of conduct the company followed from November 1995 until October 1996. The first respondent was prepared to continue to take money from potential growers of Kefir on the basis that some time in the future his belief in the marketability of the product would be vindicated and that he could persuade existing growers to give up the benefit of quota for which they paid significant amounts of money in exchange for some other future benefit as an equity holder in Good Life.

The materials show that the respondents, in the period July to October 1996, increasingly had recourse to increased sales of growerships and quota at increased prices as a means to overcome the present and projected cash flow problems of Good Life. The material satisfies me that the first respondent understood the problem being created by the conduct of the company continuing to sell growerships and quota, but he failed to desist from it.

It is clear that he would, if he had the opportunity again, engage in such conduct notwithstanding that there is no present viable commercial market for Kefir.

The submission of the ASC that the first respondent be prohibited for life from being involved in the management of a corporation involves two assumptions that are not immediately obvious as being correct. The first is that s1317EA(3)(a) empowers the court to prohibit an officer from permanently being involved in the management of a corporation. The second is that it would be a proper exercise of discretion in this case to apply the maximum prohibition available leaving it to the first respondent to persuade the Court at some future time to grant leave under s1317EF(1) of the Law to the first respondent to again manage a corporation.

Section 1317EA(3)(a) empowers the Court to make a banning order “for such period as is specified in the order”. The natural sense of the provision is that the period has a beginning and an end, and that the length of time between each will vary depending upon the particular circumstances of the case in issue. Although it may be argued that a lifetime is a period measured against the life of the officer concerned, that does not contemplate a time after the expiration of the banning order when the officer will be free to again manage a corporation. In my view an order banning a person from managing a corporation for life is properly characterised as an order prohibiting a person permanently, in contradistinction to a specified period, from managing a corporation. This distinction is clearly drawn in the other banning provisions in the Law where the section does not provide a specific (eg s229(3)) or maximum period (eg s599 and s600) during which the prohibition is to operate. For example, the ASC is given a power to prohibit “either permanently or for a specified period” in s827(2)(d) and in s830(1)(a) to prohibit permanently and in s830(1)(b) to prohibit for a specified time, a person from doing an act.

Because the ASC made no submission as to the proper construction of s1317EA(3)(a) and because I am satisfied that this case would not in any event justify a permanent ban, it is unnecessary to reach any final conclusion as to the power of the Court to make a order for permanent prohibition.

The second assumption arises because no specific submission was put by the ASC as to why the first respondent should be permanently prohibited from managing a corporation as opposed to being prohibited for a specified period of years. If the submission is that the maximum is the norm and that there is an onus on the officer to make out circumstances of exoneration or mitigation to bring about a reduction in the period, such a submission is inconsistent with the approach that the courts have historically taken to banning provisions in the context of company or corporations legislation.

In Re Civica Investments Ltd [1983] BCLC 456, Nourse J had for consideration an application of the Secretary of State for Trade under s28(1) of the Companies Act 1976 (UK) to ban a director from being involved in the management of a company for a period not exceeding five years. His Lordship said (at 458) :-

“I wish to make two further observations of a general nature which accord with two submissions made by counsel for the respondent (Mr Brougham). First, although it appears to have been the practice for the originating summons to ask for an order for the full five year period, it is clear that that is merely a maximum and that what the court has to do is to impose such a period of disqualification, if any, as it thinks appropriate, bearing in mind the upper limit of the power and disregarding its further power to give leave to act in the future notwithstanding the disqualification. Speaking for myself, I certainly would not think it right to impose the maximum period of disqualification irrespective of the degree of blame involved and then leave it to the person concerned to come back and seek leave to act in the future.

Secondly, the fact that the five year period is a maximum must, on general principles, mean that the longer periods of disqualification are to be reserved for cases where the defaults and conduct of the person in question have been of a serious nature, for example, where defaults have been made for some dishonest purpose, or wilfully and deliberately, or where they have been many in number and have not been substantially alleviated by remedial action and convincing assurances that they will not recur in the future.”

The same approach was adopted by Young J in Cullen v Corporate Affairs Commission (1989) 7 ACLC 117. His Honour had before him an appeal under s537 of the Companies (New South Wales) Code from a prohibition order made by the delegate of the Commission under s562A(3) of the Code that Cullen be prohibited for the maximum period of five years from being involved in the management of corporations. His Honour, as to the exercise of the discretion to ban a person from such activity, said (at 128 - 129) :-

“The next question is for what period should that disqualification be. There is not much authority on this point. In Re Civica Investments Ltd (1983) BCLC 456, Nourse J held that the maximum period of disqualification should be reserved for defaults of a serious nature such as dishonesty or a large number of defaults not substantially alleviated by appropriate remedial action and/or convincing assurances that they would not recur. As far as I know that case has never been departed from although I must confess I do not know of any other cases in the reports that deal with this point.

The present case was not the worst case. The delegate did not find, nor did the liquidator find, any fraud or dishonesty. The case was one of, there, inefficiency, or as the learned delegate put it, bungling. The director did not take appropriate action quickly enough to minimise loss. That he intermingled the affairs of different corporate entities, that he did not fully understand the obligations of a director and, most importantly, did not pay over group tax.

The learned delegate said that unless there were strongly persuasive circumstances which would warrant a reduction of five years he should not reduce it. He said this notwithstanding the submission of counsel for the Corporate Affairs Commission that on the facts before him it was not the worst case. Learned counsel says that he does not adhere to that submission before me because further facts have come out which make the case more serious than the evidence before the delegate suggested.

It seems to me, with respect, the learned delegate overlooked the words of Nourse J and took the view that five years’ disqualification was the norm. I am of the view that I should follow the view of Nourse J. This is not the worst case, but on the other hand it is not a trivial case and I think in all the circumstances, especially as this is one of the first cases where this sort of conduct has come under consideration for disqualification, that disqualification for two years from today would be appropriate. I have taken into account the fact in fixing this period that de facto the director has not been involved in being a director of a company since last May.”

Because the power under s1317EA(3)(a) is predominantly protective, it is relevant to have regard to the officer’s prior corporate conduct, to the present activities of the officer, to the likelihood that the officer will repeat or engage in conduct of the type which constituted the contravention of s232(4) which gives rise to the application, including whether or not the officer shows contrition or accepts responsibility for his or her conduct, and the extent to which the officer benefited from the conduct personally or tried to conceal it.

The ASC by its counsel advise that there is no known history of corporate misconduct by the first respondent and that other than lifestyle and world travel to attempt to market Kefir, the first respondent has not benefited personally in any significant way from the conduct the subject of the application. The money received by Good Life, on the material, has been expended on paying growers for product, on stockpiling and maintenance of the product, on the costs of running the company, on expenditure for research and development, and in attempting to establish and exploit a market for the product and derivatives from it. However, counsel for the ASC submits that although in part the conduct of the first respondent could be seen as having the elements of an evangelical mission to bring to the world the benefits of Kefir, his ego was such as to blindly refuse to take any advice which conflicted with his ideas. It was this trait which makes the first respondent a dangerous person to run a company, counsel submits.

The material provided by the first respondent shows an absence of contrition, a refusal to accept that what he has done was wrong, that it was unlawful and that it would ultimately lead to the company and the growers suffering financial harm because the conduct engaged in was not financially self-sustaining without immediate access to a substantial commercial market for the product. The conduct of the first respondent was obsessive and he allowed his obsession to overrule his duty as a director. In order to bring his obsession to reality he needed the financial benefits which the sale of growerships and quota provided and for that reason he refused to accept the professional advice given to him and failed to advise the growers of the true situation as to the marketability of the product. The material suggests that he is still attempting to develop a market for Kefir and there is every reason to believe that he will again attempt to use a corporate structure to raise the funds to establish a market and to acquire a stockpile of the product. In my view the past conduct of the first respondent is serious. Although there is no history of corporate misconduct or significant financial gain, the creditors and growers have incurred substantial loss and there is some evidence of particular hardship where persons have borrowed money to buy growerships and quota. This has been the real price of the personal ambition or obsession of the first respondent to supply Kefir to the world.

The first respondent is forty-four years old. He has a working life of twenty to twenty-five years ahead of him and a need to earn an income. To the extent that he makes his income from business ventures, a prohibition order will preclude him from using a corporate vehicle for such ventures in which he has a management role. This may prove to be a limitation on his ability to earn income and needs to be balanced against the public interest and the need for protection of the public from any repeat of the conduct in this case.

The requirement of protection is met by prohibiting the first respondent from managing a corporation for ten years. Although the conduct is serious, it is not within the category of a worst case which would require a longer period of prohibition.

The second respondent’s conduct I am satisfied arose from a lack of understanding of the proper role of a company director and the duty of due diligence owed by a director to the company. She had, on the material, little involvement in and little knowledge of the activities of Good Life until March 1996. A breakdown in the marriage of the respondents in March 1996 also led to the first respondent seeking to exclude the second respondent from access to company information. The evidence of the professional advisers is that effective control was with the first respondent and that it was with the first respondent that the warnings were at first conveyed.

The second respondent appears to have attempted to involve herself in the affairs of Good Life from about May 1997 and Mr Geroff acknowledges that without the second respondent’s insistence, Good Life would not have been placed in voluntary administration. The events leading up to the voluntary administration and those following it, including these proceedings, I find have operated to bring to the second respondent an understanding of what the proper role and duties of a company director are. Her present circumstances, being remarried, expecting a child, and being in receipt of social security benefits, does not suggest that there is any immediate likelihood of her taking up a management role in a corporation. However, I am not satisfied the second respondent is at this time a fit and proper person to manage a corporation. I am satisfied that as a personal deterrent and as a deterrent to others who may be minded to engage in like conduct or adopt a passive role when such conduct occurs, the second respondent should be prohibited from managing a corporation for a period of three years.

Penalty

The ASC is seeking a penalty of $100,000 against the first respondent and $10,000 against the second respondent. The penalties sought represent 1,000 penalty units and 100 penalty units respectively. The Court does not have the power to order a civil penalty unless it is satisfied that the contravention was a serious one: s1317EA(2). Although “serious” is not defined, in the context it means that the default or neglect which constitutes a breach of the requisite duty must be grave or significant. In my view that test is satisfied in the instant case.

The question is whether a pecuniary penalty ought to be imposed against the first or second respondent in this case.

Section 1317EA(3)(b) is punitive in character. Its purpose in an appropriate case is to punish, but principally imposition of a pecuniary penalty is to act as a personal deterrent and a deterrent to the general public against a repetition of like conduct. The legislative deterrent effect is aimed at preventing a corporate structure being used by an individual in a manner which is contrary to proper commercial standards to the detriment of the company, its shareholders, creditors, investors and others dealing with it. If compliance with the appropriate standards of commercial conduct in the management of corporations by deterrence is the object, then any penalty should be no greater than is necessary to achieve this objective. Otherwise, severity beyond that figure would be oppressive: Trade Practices Commission v Stihl Chain Saws (Aust) Pty Ltd [1978] ATPR 17,882 at 17,896; NW Frozen Foods v Australian Competition and Consumer Commission (1996) 71 FCR 285 (FC) at 293. Further, the appropriate civil penalty is in each case a question of fact and the circumstances of one case cannot dictate the appropriate penalty in different circumstances in another case: NW Frozen Foods at 295.

In the present case the first respondent has shown no contrition or remorse nor accepted any responsibility for the failure of Good Life or for the damage and loss sustained by persons who he and others on behalf of Good Life persuaded to purchase growerships and quota to produce Kefir.

There is no suggestion that the first respondent set out to defraud these persons or creditors of the company or that he intended to mislead or deceive them. Rather, the conduct may more properly be categorised as an obsessive pursuit of a sincerely held belief of the first respondent.

The monetary losses in the instant case are large irrespective of whether or not the respondents were personally financially advantaged by what has occurred. In this case there is a need for personal deterrence in the case of the first respondent for reasons I have outlined earlier. That deterrence is in part met by an order prohibiting him from managing a corporation for a significant period of time.

The conduct of the first respondent falls into the serious category, but not into the worst case of conduct. This is because there is no evidence of other corporate misconduct, whether in the past or concurrently with this conduct. The object of the imposition of a civil penalty in the present case is met, in my view, with the imposition of a penalty of $40,000.

The position of the second respondent is quite different to the first respondent. The gist of her default is failing to properly involve herself in the business affairs of Good Life and failing to take remedial action earlier than she did.

She has shown remorse and contrition and has repaid her loan account from the proceeds of the sale of the former matrimonial home. She did act upon the advice of the professionals to insist that Good Life was placed in voluntary administration. She has not contested these proceedings which is a factor to be taken into account in her favour.

In my view the need for public deterrence of others nominally holding directorships but ignoring the duties attaching to such a position and allowing others to engage in conduct of the type engaged in by the first respondent requires the imposition of a pecuniary penalty. An appropriate penalty is $4,000.

The respondents must pay the costs of the ASC of and incidental to the application, including reserved costs, if any, to be taxed if not agreed.

I certify that this and the preceding thirty-eight (38) pages are a true copy of the Reasons for Judgment herein of the Honourable Justice Cooper

Associate:

Dated: 20 August 1998

Counsel for the Applicant:	C E Holmes
Solicitor for the Applicant:	Australian Securities Commission

No appearance for the First Respondent

Advocate for the Second Respondent:	G Taylor

Date of Hearing:	9 March 1998
Date of Judgment:	20 August 1998

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