2007 Oxford Business & Economics ConferenceISBN : 978-0-9742114-7-3
The liability of Corporate Agents for negligent misstatement: A critique of the decision in Trevor Ivory Ltd v Anderson and recommendations for reform in New Zealand
Alamelu (Ala) Sonti, Barrister and Solicitor of the High Court of New Zealand
ABSTRACT
In the last two decades, a number of cases have come before the courts in which the personal liability of company directors has been called into question. The cases have highlighted that the courts have failed to articulate a consistent and coherent model for finding directors personally liable for their actions. As an illustration, in claims that have been brought against directors for negligent misstatement, the courts have prioritised preservation of the corporate form over ensuring third-party clients receive an adequate remedy for losses they have suffered. In this situation, clients of the company are left in the unenviable position of wearing the loss they have suffered because they are unable to recover it from the company and/or its director(s)/officers. The paper argues that strict adherence by the courts to long-established principles of company law, including theprinciples of limited liability and separate legal entity, have resulted in inconsistent results, which in turn has created uncertainty in the law, and needs to be addressed. The paper reviews common law developments that have taken place in other commonwealth jurisdictions and offers alternative solutions which address why directors should be held personally liable in New Zealand. This will be done by ensuring that other relevant areas of the law are systematically applied to the cause of action in question, rather than corporate theory alone. It is anticipated that this will result in a more principled approach which is likely to produce consistent and fairer results in the future.
INTRODUCTION
In 1993, the New Zealand (“NZ”) Court of Appeal handed down its decision in Trevor Ivory [1992] 2 NZLR 517 (“Trevor Ivory”). This controversialdecision was the first case to hold that a director was not personally liable in tort for negligent advice given in the course of carrying out the business of his company. From a precedent perspective, the decision contained a number of concerning inconsistencies. The Court of Appeal misapplied the doctrine of limited liability; the ‘assumption of responsibility’ test set out in Hedley Byrne & Co Ltd v Heller & Partners [1964] AC 465 (“Hedley Byrne”) and the Tesco Supermarkets v Nattrass [1972] AC 153 (“Tesco”) doctrine. In addition to the lack of precedent authority, the court of appeal’s decision had no express mandate from the Companies Act 1993 (“The Act”). The Court therefore acted outside of the statutory framework in NZ.
It is submitted that the uncertainty that currently pervades this area of law needs to be addressed for the benefit of society as a whole and for the benefit of the economy. From an economic perspective, people dealing with companies must have confidence that the law will afford them a remedy if they are financially disadvantaged in their dealings with them. Directors would also benefit by knowing what is expected of them in terms of their duties to the company, to clients, andto creditors. Greater accountability and responsibility by directors in this regard is urgently called for. In the next section, the decision in Trevor Ivory will be analysed.
Trevor Ivory [1992] 2 NZLR 517
Facts
The plaintiffs (Mr and Mrs Anderson) owned an orchard which included a raspberry plantation. Mr and Mrs Anderson contracted with Mr Ivory’s company, Trevor Ivory Limited, for Mr Ivory’s expert advice regarding the management of their raspberry plantation.Mr Ivory, an agricultural and horticultural advisor, recommended that they use Roundup (a powerful herbicide) to control the growth of couch grass, which was threatening their plants. However, he failed to advise the Anderson’s to protect theplants before spraying and as a result the plants absorbed the herbicide and died, with the result that they ultimately had to be dug out. The Anderson’s incurred significant losses and sued both the company and Mr Ivory personally in contract and tort. The High Court found the company liable for breach of contract and negligence and found Mr Ivory personally liable. Damages of $145,332 were awarded against both defendants. Mr Ivory appealed against the judge’s finding that he was personally liable (p. 517).
Court of Appeal Decision
Mr Anderson appealed against the finding in the High Court that Trevor Ivory was not personally liable. The Court of Appeal held that an officer or servant of a company might in the course of activities carried out on behalf of the company, come under a personal duty to a third party, breach of which, might entail personal liability. The Court decided that the test as to whether liability had been incurred was whether there had been an assumption of a duty of care, actual or imputed. In this regard, liability would depend on the particular facts of the case including the degree of implicit assumption of personal responsibility and the balancing of policy considerations. The Court noted that on the formation of his company, Mr Ivory made it plain to “allthe world” that limited liability was intended and consequently, if liability was imposed on him, his object would be undermined. Furthermore, there was no just and reasonable policy consideration for imposing an additional duty of care. Mr Ivory was therefore not personally liable to the Anderson’s (pp. 519-532).
Critique of the Court of Appeal’s decision
In making their decision, the court of appeal made several significant errors. Long-established legal principles were given new definition either by being misapplied or extended without legal authority. Established case law doctrines were also misapplied, and finally no consideration was given to the policy reasons in favour of affording innocent third-parties a remedy. Interestingly, and from an equitable perspective, the less than honest intentions of Mr Ivory were used to exculpate him and clothe him in corporate immunity, rather than being used to find him personally liable.
Misapplication of the doctrine of limited liability and the separate entity principle
The doctrine of limited liability originally evolved for the benefit of a company’s shareholders. A company’s limited liability was said to arise because companies are artificial legal entities that are treated in law as entirely separate from their shareholders. The rationale behind this principle is that it encourages investment in a company by ensuring that no liability will attach to the shareholders if the company encounters financial difficulties. Consequently, shareholders are not personally liable for the company’s debts or other obligations, and cannot be sued by the company’s creditors. The principle of limited liability is therefore to protect the company’s shareholders, not the company or its officers (Grantham, 1997).
In Trevor Ivory, the Court of Appeal extended the limited liability principle to protect directors from personal liability for their tortious actions. This novel extension took the principle out of its original domain of dealing with property ownership and company debts and into a new domain: to cover the tortious activities of directors. Cooke P (as he was then) was emphatic in his argument that limited liability should be available to protect directors as a matter of policy. As he stated (pp. 523-524):
[I]t behoves the courts to avoid imposing on the owner of a one-man company a personal duty of care which would erode the limited liability and separate entity principles associated with the names of Salomon and Lee…the object of Mr Ivory in forming a limited liability company, an object encouraged by long-established legislative policy, would be undermined by imposing personal liability…when he formed his company, Mr Ivory made it plain to all the world that limited liability was intended.
However, Cooke P’s reasoning was not supported by the decisions in Salomon v Salomon & Co Ltd [1897] AC 22 (“Salomon”) and Lee v Lee’s Air Farming Ltd [1961] AC 12 (“Lee”),which confirmed that limited liability protected shareholders only. His reasoning also lacked legislative authority. Section 97 of the Companies Act 1993 which deals with the liability of shareholders states that:
[A] shareholder is not liable for an obligation of the company by reason only of being a shareholder…the liability of a shareholder to the company is limited to any amount unpaid on a share held by the shareholder.
This section does not include protection for a director’s personal liability in tort. Cooke P focused on Mr Ivory’s ‘desire for protection’, but this does not mean that any such protection is available in law (Wishart, 1993a).
A similar criticism can be made of the Court of Appeal’s application of the separate entity principle. In Trevor Ivory, the Court spoke of Mr Ivory’s actions as if they were those of the company itself. As Hardie Boys J noted: “the problem that has vexed the common law courts in this area is that of respecting the doctrine of separate legal personality on the one hand and of allowing an adequate remedy on the other.” (p. 525). Phrased in this way, Hardie Boys J inferred that because of the separate legal personality of a company, this somehow precludes the existence of personal liability for directors (Anderson, 2004). In fact several academic commentators have criticised this ‘fusing’ of the two entities: namely the company and its directors and have labeled this is as anthropomorphism that somehow reifies the company. In Trevor Ivory the court held that Mr Ivory was not liable because he was acting ‘as the company’. That is, in certain circumstances a director’s actions are in fact the actions of the company. While there is no doubt that a company is a ‘legal person’ and to that extent it can do things that natural legal person’s can do, like borrow money and purchase property; it is still an artificial legal entity which has no physical presence (Grantham & Rickett, 2002). It is unable to do any of these things without authorised personnel entering into contracts on its behalf. This is typically why the management of a company’s affairs must be vested in natural persons, typically its directors.
The central question that must therefore be asked is who has vested in them the right and power to activate the company to perform juristic acts? (Grantham et al., 2002). As we know, shareholders are typically only concerned with ownership and investment issues, whereas directors have full decision-making power. Therefore, there is a clear divorce between ownership and control, which in turn explains why limited liability only extends to the shareholders of the company. Although it is acknowledged that the law has developed theories to attribute human behaviour to the company (such as the attribution and identification theories),this has been done in a way that fuses the human actor to the company, instead of separating out the guilty human being from the company, in order to isolate the guilty actor. In tort and crimes actions, there must be an identifying human being to take an action against. There are no good reasons why this should be any different in a corporate context. The decision in Trevor Ivory therefore white-washes individual liability by fusing it with the corporate form (Borrowdale, Rowe, & Taylor, (2002). By contrast, the proper use of agency and tort principles separates out the individual to pin liability on, and is discussed later in the paper.
Misapplication of the Identification Theory
The identification theory was first developed in Tesco Supermarkets Ltd v Nattrass[1972] AC 153 (“Tesco”). The theory identifies the acts and knowledge of those in control of the company as those of the company. On this basis, only the company will be liable (Wishart, 2003b). To this extent it differs from the law of agency in that it effectively merges, for legal purposes, the individual and the company into one entity (Wishart, 2003b). In Tesco, the company sought to distance itself from the store manager by arguing that it was his acts that led to a breach of the Trade Descriptions Act 1968. The House of Lords decided that the intention of the company was not in fact the intention of the store manager because he was not sufficiently senior, unlike a managing director for example, who carries out the functions of management and speaks and acts for the company. The Act provided a defence if a defendant company could show that the offence was due to the act of “another person” and the defendant had taken all reasonable precautions.
The House of Lords held that the defence was open to the company because the employee was “another person” and not the “directing mind and will” of the company. Therefore, it is the mind of the controlling individual which is the mind of the company. However, in Trevor Ivory the Court of Appeal reversed the identification theory by holding that Mr Ivory’s negligent advice was the in fact the company’s negligent advice and on this basis he was exempt from personal liability. That is, the Court of Appeal declined to hold Mr Ivory personally responsible because he was in fact ‘identified’ with his company, therefore only the company could be held liable to the Anderson’s.
A case which illustrates the absurdity of the Tesco doctrine is Nordick Industries Ltd v Regional Controller of Inland Revenue[1976] 1 NZLR 194 (“Nordick”). Cooke J (as he was then) applied the Tesco doctrine and accepted that the director’s actions of making a false return to the Inland Revenue should be treated as the actions of the company, even though the director was acting fraudulently. This logic was strongly criticized in subsequent cases such as Director of Public Prosecutions v Gomez [1993] AC 442 (“Gomez”). In Gomez,Lord Browne-Wilkinson suggested that such a contention was illogical because if the individual was senior enough to be identified with the company, the company must have consented to the director’s actions. Such an action is not however in the best interests of the company and as a legal person, the company would not authorise (or have its senior management or directors authorise such acts). The ruling in Nordick surely cannot be correct especially where fraud or dishonestyare involved. Similarly in Ivory, the ‘one-person’ company as a legal person would never have consented to Mr Ivory’s negligent advice, which he gave as an employee of the company. Also, his admission that he formed the company to avoid liability showed his dishonest intentions. A director should not be allowed to argue that his actions were those of the company. This would effectively preclude any action being taken against the individual and runs counter to long-established equitable principles.
For these reasons, it is submitted that doctrines which merge an individuals actions with those of the company for the purposes of avoiding individual liability, are wrong in principle. This encourages dishonesty on the part of senior management and ultimately leads to the spread of losses onto third parties who contract with the company.
In fact in the Privy Council[1] decision of Meridian Global Funds Management Asia Ltd v Securities Commission[1995] 3 NZLR 7 (“Meridian”),Lord Hoffman stated that the identification doctrine used in Trevor Ivory was a ‘last resort’ rule of attribution, which should only be used by the courts if general principles of agency were insufficient in giving meaning to a substantive rule of law in relation to a legal person (p. 12). The liability of Mr Ivory could have easily been determined using the law of agency. There was therefore no need for the Court of Appeal to resort to the Tesco Identification doctrine.
In the sections that follow, consideration is given to the role of equitable doctrines in situations where the ‘corporate personality’ is used for improper purposes. Section 133 of the Companies Act 1993 will also be examined because it expressly states that “directors must exercise their powers for a proper purpose”. In addition to this, section 131 states that “directors must act in good faith when exercising powers or performing duties”.
Lifting the Corporate Veil
The concept of the separate legal entity of a company and the resulting limitation of liability is statutorily enshrined in section 15 of the Companies Act 1993. Section 15 states that “a company is a legal entity in its own right separate from its shareholders and continues in existenceuntil it is removed from the New Zealand register.”
As a general rule, as long as the company has been established for legitimate reasons, the courts will not lift the veil which is said to ‘hang’ between the shareholders and the company. However, the courts will not allow the corporate form to be used as a device to evade contractual or other legal obligations[2] or for the purposes of fraud or improper conduct. In Gilford Motor Co Ltd v Horne[1933] 1 Ch 935 (“Gilford”) and Jones v Lipman[1962] 1 WLR 832 (“Jones”), the English courts held that the ‘fraud exception’ which allows a court to lift the corporate veil would be invoked if the defendant had the intention to use the corporate structure in such a way as to deny the plaintiff some pre-existing legal right. In Gilford for example, Mr Horne, an ex employee of Gilford Motor Company Ltd (“GMC”) incorporated a limited liability company in the name of his wife, in order to circumvent a clause in his employment contract, which prevented him from setting up in competition with GMC following the termination of his contract. The court held that the company was formed as a device in order to mask the effective carrying on of the business of Mr Horne. Similarly in the Jones case, Mr Lipman had agreed to sell a property to the Jones,’ however prior to its completion he set up a company and sold the house to the company, which was in his absolute control. The intention was to deny the plaintiffs the remedy of specific performance. The court held that the company was a mask, which Mr Lipman held before his face in an attempt to avoid recognition by the eye of equity.