Directors warned not to keep secrets: Hakea Holdings Pty Ltd v McGrath (No 2) [2022] FCA 995.

By Alicia Hill, Principal, and Helena Swidron, Law Clerk

On 26 August 2022, the Federal Court of Australia delivered judgment in the matter of Hakea Holdings Pty Ltd v McGrath. This case concerned a director’s choice to not disclose vital information regarding a construction project, which ultimately lead to significant delays and additional costs. This issue required the Court to consider the factual circumstances surrounding the case to determine whether this non-disclosure amounted to a breach of directors’ duties. In his decision, Justice Yates conveys the importance of knowing your duties under the Corporations Act 2001 (Cth) and the ability to keep personal interests out of business decisions.

Background

Steven James McGrath was one of the directors of Hakea Holdings Pty Ltd (Hakea). McGrath was also the sole director, shareholder, secretary and general manager of another company, Denham Constructions Pty Ltd (Denham). In 2012, Denham entered into a contract with Hakea to design and construct a residential aged care facility on property owned by Hakea. The contract was valued at $17,700,000.00 and under the contract, Denham was obliged to carry out and complete the construction works by the specified completion date. Originally, the period for completion was 74 weeks. However, evidence throughout the proceedings showed that this date was delayed by several months. Under the contract, if the works were not completed by the date of completion, Denham was liable to Hakea for damages up to $2,500 per day, which would commence 6 weeks after the date of completion.

In 2015, Denham fell into severe financial distress, and potentially insolvency, which meant it was not able to complete the project. However, despite this development, McGrath did not inform Hakea and continuously assured Hakea that Denham could complete the project.

Issue

In 2017, Hakea alleged that McGrath breached its director’s duties under section 180(1) of the Corporations Act 2001 (Cth) (the Act). This section requires directors and other officers of a company to exercise their powers and discharge their duties with a degree of care and diligence that a reasonable person in the director’s position and circumstance would have.

Hakea argued that as a director of Hakea, McGrath should have informed Hakea of Denham’s financial difficulties. In failing to do so, he did not act with the required degree of care and diligence. Hakea claimed that had it known about Denham’s financial state, Hakea would have enforced its contractual right to have Denham removed from the project and to reappoint a new builder. If Hakea were able to action this, it would not have experienced the significant delays or suffered the financial consequence of being mislead by McGrath about the completion of the project.

Hakea sought equitable compensation for the breach.

 Decision

The Court found that McGrath breached his duty to Hakea under section 180(1) of the Act by not disclosing Denham’s financial status to Hakea.

No orders were made as to the quantum of the loss or damaged suffered by Hakea.

Judgment

In coming to the above conclusion, the first point the Court had to consider was whether it was satisfied that Denham was in financial distress. In determining so, the Court considered several factors, including:

• Denham transferring its employees to another company at the time it had high debts owing to the Australian Tax Office (ATO);
• Denham’s inability to discharge its ATO debts;
• The issuance of a statutory demand by the Deputy Commissioner of Taxation for the debts owing by Denham; and
• A subcontractor of Denham’s obtained a garnishee, of which Denham was the garnishee.

As the above factors strongly pointed towards financial hardship, it was clear to the Court that Denham was under financial distress.

Secondly, the Court had to determine whether McGrath had breached his duty of care and diligence under section 180(1) of the Act. In doing so, the Court considered the following factors:

• Out of all the directors of Hakea, McGrath was in a unique position to know of Denham’s financial position as he was its sole director. Thus, he was the only Hakea director who could gauge Denham’s ability to complete the project. No other directors could have possessed such knowledge. Therefore, the Court held it was likely that he deliberately did not disclose the circumstances to Hakea;
• The importance of the information, it was essential for the directors of Hakea to know. Therefore, in choosing not to disclose the circumstances to Hakea, McGrath was going against the interests of Hakea; and
• The Court could not determine a reason as to why McGrath would not disclose the information to the directors, other than McGrath having the awareness that if he did, it would jeopardise the continuation of the building project. As McGrath was an experienced builder, it was likely that he knew Hakea would have removed Denham from the project if they knew of the circumstances.

The Court noted that had McGrath not been the sole director and shareholder of Denham, but still came to know by some means of Denham’s financial situation, and still failed to disclose such to Hakea, the same decision would have been made regardless.

Through this, Justice Yates made it apparent that just because McGrath was also a director of Denham, did not mean that he would be subject to a lesser standard of care.

The Court also noted that it did not consider deliberateness in great depth, as it is not an essential element in finding a breach of section 180(1) of the Act.

 Takeaways

Justice Yates in this case has proven the importance for directors to understand their duties and obligations under the Act. Undertaking a position as director is not a light-handed decision, and it comes with great responsibility. To ensure that you are not at risk of breaching your director duties, it is essential to refresh your knowledge of the Act, and ensure you are keeping up to date with any changes to the legislation.

More specific to this case, it is vital to ensure that when acting as a director, the company’s interests are put first, not your own. Although it may be a difficult decision to go against your own interests, a director has an obligation to its company.

A finding of a breach of directors’ duties can not only amount in financial burdens, but also reputational damage too. Therefore, it is best not to risk any breaches as the consequences can be vast.

If you have any questions regarding this decision or any matters raised by it, please feel free to get in contact with Alicia Hill of the MST Dispute Resolution and Litigation team on (03) 8540 0200, or by email at alicia.hill@mst.com.au.