this product is unavailable for purchase using a firm account, please log in with a personal account to make this purchase.

Consent no defence to fraudulently applying company property

Feature Articles

Cite as: (2003) 77(9) LIJ, p.44

A recent High Court decision has significant implications for sole director proprietary companies.

By James McConvill

In its decision in Macleod v R,[1] the High Court of Australia has upheld the rule established more than a century ago by the House of Lords in Salomon v Salomon & Co Ltd[2] that a company is a separate legal entity to its directors and shareholders – even when the director is also the sole beneficial shareholder and effectively controls the affairs of the company.

Although a director who is also the company’s sole shareholder is perhaps the only person ever involved in the company, and from a practical perspective the day-to-day interests of the company are the same as that person, the Macleod decision confirms that the company remains a separate legal entity and the rights and interests of the company are necessarily distinct from the rights and interests of the company’s shareholders.

Background

The case arose out of a film production scheme which Macleod (the appellant) carried on between 1989 and 1994, which was designed to take advantage of certain taxation concessions offered under Division 10BA of Part III of the Income Tax Assessment Act 1936 (Cth) (ITAA). The appellant was a director of three companies (Trainex, Starlight and CEN), which offered investment opportunities in films and videos. Several thousand investors took advantage of the “investment opportunities”, contributing more than $6 million in total to Trainex.

Under each investor’s deed, Trainex was required to hold the invested funds on trust for the purpose of film production and was obliged to proceed with production once the budgeted film production costs had been raised. According to the judgment, of the total funds raised, only $718,000 was actually used to make films, with more than $2 million being applied by the appellant for his own personal use, including purchasing a home unit on the Gold Coast. During this time, the appellant provided investors with “income statements” creating the false impression that films were being made and returning profits.

In March 1999, the appellant was convicted in the District Court of New South Wales of 19 counts on indictment, involving the contravention of various state and commonwealth statutory provisions. Five of the counts on which the appellant was convicted involved the contravention of s173 of the Crimes Act 1900 (NSW) (Crimes Act). The NSW Court of Criminal Appeal subsequently dismissed the appellant’s appeal against conviction on each of the five counts of contravening s173 of the Crimes Act. The appellant appealed the decision to the High Court.

Offence of fraudulently applying company property for personal use

Section 173 of the Crimes Act presently states:

“Whosoever, being a director, officer, or member, of any body corporate, or public company, fraudulently takes, or applies, for his own use or benefit, or any use or purpose other than the use or purpose of such body corporate, or company; or fraudulently destroys any of the property of such body corporate, or company, shall be liable to imprisonment for 10 years”.

Section 173 of the Crimes Act, for which equivalent provisions exist in the other states and territories, comprises three elements:

(i)  the taking or application of company property by a company director, officer or member;

(ii)  for his own use or benefit, or any use or purpose other than the use or purpose of the company; and

(iii)  that the taking or application was fraudulently made.

The second element of s173 was given particular attention by the High Court. According to the court, the second element, which clearly distinguishes between the use or benefit of a director or shareholder and the use or purpose of the company, is an example of the use of statutory offences designed to overcome many of the complex distinctions and restrictions of the common law crime of larceny (also referred to as “theft”).

Historically, under the common law if a person took away property belonging to another with the intention of permanently depriving the owner of the property, and had the consent of the owner or genuinely believed that they had a right to obtain the property, the crime of larceny was not committed. Accordingly, it was impossible for directors and other company officers who were entrusted to deal with company property on the company’s behalf to be convicted of larceny.

Issues before the High Court

Given this background, what the High Court was asked to decide was whether a claim of consent still remained irrelevant to a charge of fraudulently applying a company’s property even when a person was not only the controlling mind of the company, but also the sole beneficial shareholder in the company. Is it not the case that a controlling director who as the sole beneficial shareholder consents to the company’s funds being allocated for his or her personal use, uses those funds consistent with the purposes of the company? This required the Court to consider how the separate legal entity principle affects the statutory offence of fraudulently applying a company’s property for personal use.

The other issues that the High Court was asked to decide were: (1) did the trial judge misdirect the jury as to the meaning of “fraudulently”? and (2) were the directions of the trial judge on the application of the defence of claim of right necessary or appropriate? This article focuses on the issue of consent and does not discuss the High Court’s consideration of the latter two issues.

Decision of the High Court

The High Court unanimously dismissed the appeal. According to the Court, a director cannot give a valid consent on the company’s behalf to a fraudulent application of company property for the director’s personal use. Even if a company is in essence a one-person business, a company is an entity separate from that person.

Accordingly, s173 of the Crimes Act, and equivalent provisions in other jurisdictions, creating the offence of fraudulently applying property of the company for personal use, must be construed in light of the distinction between the company and those who are its directors, shareholders or both.

The question to address is whether the director or shareholder has fraudulently applied the company’s property other than for the use of the company. The following statement from Callinan J in Macleod is useful:

“ ... The appellant’s submissions would, if correct, mean that no matter how the appellant chose to use Trainex’s money, the company (by him) could always validate that use by consenting to it. I cannot accept this submission. It ignores the vital distinction which the law draws between separate legal personalities. It is a distinction which s173 itself makes. The funds or property of a company can only be used or applied as the result of some act or conduct on the part of a natural person. The fact that the natural person so acting is in effective control of the company does not mean that he is the company, or that no distinction may be drawn between what he does and what the company may and should lawfully do”.[3] (emphasis in original)

The decision’s implications

The High Court has made clear that under Australian law a director is not entitled to raise consent as a defence to fraudulently applying company property for personal use, notwithstanding that the director is the sole beneficial shareholder of the company. What is particularly important about this decision is that the principles established are equally applicable to sole director proprietary companies, where the company is truly a one-person business, and the director may routinely use the company’s funds as their own. Sole director proprietary companies[4] have been allowed under the Corporations Act 2001 (Cth) since the Company Law Reform Act reforms of 1998.[5]

While in practice, the line between company and person in sole director proprietary companies is particularly blurred or non-existent, the High Court’s decision reinforces that the company and person are separate legal entities, and to avoid potential criminal liability, it is a line which needs to be clearly drawn and kept in mind when dealing with the company’s property.


JAMES MCCONVILL is a lawyer working in the corporate and commercial department of Allens Arthur Robinson, Melbourne.


[1] (2003) 197 ALR 333.

[2] [1897] AC 22.

[3] Note 1 above, at 359.

[4] It should be noted that public companies are still required to have at least three directors, of which at least two directors must ordinarily reside in Australia: Corporations Act, s201A(2).

[5] Corporations Act, s201A(1).

Comments




Leave message



 
 Security code
 
LIV Social
Footer