Directors Beware – Personal Liability for Misleading Contractual Promises


The Australian Consumer Law (ACL) can render directors personally liable for misleading or deceptive conduct engaged in on behalf of a company in commercial transactions.

A contractual promise will imply representations about the present intent and ability of the company to perform the promise.  It is critical that reasonable grounds can be demonstrated for making these representations, because the potential personal exposure of the director who transacted the deal can otherwise be devastating.

This was illustrated in the recent decision of the Western Australian Supreme Court in Grande Enterprises Ltd v Pramoko [2014] WASC 294, delivered on 22 August 2014, where the director in question has effectively been ordered to personally acquire an asset sold by him on behalf of the company, at a price of $2,250,000.

Background

In 2008, Grande entered into an agreement to purchase 30 million shares in Zen Resources Ltd from Southern Cross International Investments Ltd, a company incorporated in the British Virgin Islands.  The purchase price was $2,250,000.  The agreement was signed by both parties in Western Australia and Mr Pramoko, a director, signed on behalf of Southern Cross.

The agreement contained a clause to the effect that if Zen was not taken over by a company listed on the Australian Securities Exchange or not itself listed on a major stock exchange within two years, then Southern Cross would buy back the shares from Grande for the same price.

Zen was not in fact taken over by a listed company or itself listed on a major stock exchange.  Southern Cross failed, despite demand, to buy back the shares.  In 2011, Grande commenced proceedings in Western Australia against Mr Pramoko.  It alleged misleading and deceptive conduct in connection with the promise that Southern Cross would buy back the shares, as well as a further promise that it contended had been made by Mr Pramoko, that he would personally buy back the shares if Southern Cross was unable to do so.  Grande sought in effect to recover the amount paid for the shares.

The Judgment

Grande failed to prove that Mr Pramoko had promised to personally buy back the shares.  This was not, however, the limit of his personal exposure.

His Honour Le Miere J concluded that there was misleading conduct on the part of Mr Pramoko personally in connection with the promise made on behalf of Southern Cross, and that the appropriate order was for Mr Pramoko to pay Grande $2,250,000 and for Grande to transfer its Zen shares to Mr Pramoko.  Interest was awarded in the amount of $362,835.62.

There are a number of important lessons to be learnt from the judgment.  Whilst his Honour was dealing with liability under an older legislative scheme, the same principles continue to be relevant today in relation to the application of the ACL.

Lesson 1 – Implied Representations as to Intent and Ability to Perform

It is not just pre-contractual representations that are subject to the prohibition against misleading or deceptive conduct, it extends to contractual promises as well.

Whilst acknowledging different views on the issue, his Honour followed authorities to the effect that:

  1. a contractual promise will imply representations as to present intent and ability to perform the promise; and
  2. these representations are “with respect to future matters”.

Lesson 2 – Reasonable Grounds

When a representation is “with respect to a future matter”, it is deemed to be misleading, unless the defendant can show that he or she had reasonable grounds for making the representation.  The inquiry is objective, such that a genuine or honest belief on the part of the defendant is relevant but not sufficient.

Mr Pramoko therefore had to prove that it was reasonable for him to represent that Southern Cross intended to buy back the shares and had the capacity do so, in the event that Zen was not taken over by a listed company or itself listed on the stock exchange within two years.

His Honour found that this did not require proof that Southern Cross had sufficient assets and expected cash flow such that it was likely to be able to buy back the shares using its own money.  Instead, the evidence was examined with a view to determining whether, as a matter of commercial reality, a third party was willing to advance the necessary funds unsecured.  The evidence failed to establish that there was a sufficiently reliable source of funds and therefore the promise that Southern Cross would buy back the shares was misleading or deceptive.

Lesson 3 – Primary Liability of Director

Grande confirms authorities to the effect that a director can be held liable if they are responsible for the misleading conduct of a company.  In effect, the conduct is both that of the company and that of the director personally.  Significantly, it is not necessary to prove that the director knew the conduct was misleading or deceptive.

Mr Pramoko signed the agreement in his capacity as a director and therefore personal liability was established on his part.  This meant that Grande could pursue its claim against him directly, as an alternative to pursuing Southern Cross.

Lesson 4 – Proportionate Liability

If faced with a claim for economic loss in an action for damages based on misleading or deceptive conduct, it is important to examine the conduct of other parties who may bear partial responsibility for the loss.

For example, Mr Pramoko pointed to the director of Grande as a concurrent wrongdoer, as he had conducted a due diligence before deciding to enter into the agreement.  Mr Pramoko asserted that the failure of that due diligence to predict what happened was a cause of the loss sustained by Grande.

Had it been successful, this assertion may have served to reduce Mr Pramoko’s exposure to an amount reflecting the proportion of Grande’s loss that the court considered just, having regard to the extent of his responsibility.  It was not successful and so the apportionment claim failed.

Lesson 5 – Relief Where Damages Difficult to Assess

A final and very important point to note from the decision in Grande is the form of the relief granted.

In the case of the purchase of an asset induced by misleading conduct, the general measure of damages (apart from consequential losses) is the difference between the amount paid by the plaintiff for the asset and the value of the asset as at the date of purchase.   If the investment cannot be realised, the court may consider valuing the asset as at the date of trial instead.

In Grande the method of assessment was complicated further, because the evidence established that there was no market for the shares.  His Honour considered that Zen, through its subsidiaries, held assets which might have some value, but that this value was difficult to assess.

Under the ACL there is an alternative form of relief to damages, allowing the court to make such orders as the court thinks appropriate to compensate wholly or in part the person who has suffered the relevant loss.  His Honour points to a number of cases where equivalent forms of relief have been used by courts to set aside a transaction.

In light of the difficulties in assessing the value of the Zen shares, his Honour did indeed grant an alternative form of relief.  Given that Mr Pramoko was pursued personally as a director, this did not however involve the transaction being set aside, which after all was an agreement between Grande and Southern Cross.  Instead Mr Pramoko was, in effect, ordered to acquire the shares purchased by Grande from Southern Cross, for the same purchase price paid by Grande.

A Word of Caution

The decision in Grande demonstrates that for a director, engaging in misleading or deceptive conduct when entering into a commercial transaction on behalf of a company can have severe personal consequences.  It is one example of how personal liability can arise notwithstanding the use of a corporate entity to conduct business.  Do not assume that as a director the risk associated with a deal is the company’s risk alone.  It may come back to haunt you.

For more information on this update or any other matters concerning directors’ liability or commercial disputes, please contact Katrina Welch or Tom Darbyshire on (08) 9321 3755.

The information published on this website is of a general nature and should not be construed as legal advice. Whilst we aim to provide timely, relevant and accurate information, the law may change and circumstances may differ. You should not therefore act in reliance on it without first obtaining specific legal advice.