Recent changes to the proposed criminalisation of breaches of directors' duties

 

Anastasiya Gutorovan The proposed law to criminalise serious breaches of directors’ duties has recently undergone significant changes when Supplementary Order Paper (SOP) 403 was released on 19 November last year. This is the second revision of its kind and was done in anticipation of the Committee of the Whole House stage due to commence shortly.

By way of background, the Companies and Limited Partnerships Amendment Bill (the Bill) was introduced in 2011 with a view to tightening controls around company management and raising business confidence to ensure New Zealand continues to attract steady domestic and international investment. Two major events contributed to the introduction of the Bill.

The first was international criticism of New Zealand’s liberal company laws and procedures, and the ease with which they can be subjected to abuse. Such abuse was highlighted in 2009 by the SP Trading Limited incident which linked a New Zealand registered company to one of the largest international arms trafficking deals of that year. In response, the Bill curbs the potential for such abuse by requiring every company to have an agent residing in New Zealand (or Australia) and endows the Registrar of Companies with enhanced investigatory powers.

The second event which contributed to the introduction of the Bill was the recent series of finance company collapses which resulted in a stampede of company director prosecutions and convictions. The public perception of the directors’ “egregious” conduct called for a change in the law to ensure tighter controls are implemented to prevent or at the very least limit such conduct in the future.

The government responded with a plethora of legislative reforms to address the perceived inadequacies in the law, primarily directed at financial service providers and issuers of securities. The Bill contributed to these reforms by introducing criminal liability for breaches of certain directors’ duties for the first time in
New Zealand.

Under the current legislation, all company directors are subject to a number of duties contained in the Companies Act 1993. These duties are civil and are owed to and enforced by the company itself, which reflects the fiduciary nature of the relationship. Alongside these duties, there are various criminal provisions in the Companies Act and the Crimes Act 1961 to address certain more specific transgressions which are not reserved for directors only. These include causing loss by deception, fraudulent use of property, and theft by a person in a special relationship. There are also certain more restrictive provisions which affect defined classes of companies, such as issuers of securities or financial service providers, but have no wider application beyond that.

The Bill initially proposed attaching criminal penalties to two of the existing duties under the Companies Act – the duty to act in good faith and in the best interests of the company under section 131, and the duty not to trade recklessly under section 135. The proposal was met with strong criticism directed at both the substance and the form of the amendment. The key argument advanced in opposition to the form of the original amendment was the unsuitability of an ambiguously worded civil duty to serve as the basis for criminal liability. This criticism was addressed in SOP 249 in June 2013, which unveiled the first round of changes to the Bill.

SOP 249 created new comprehensive stand-alone provisions to serve as bases of the two new criminal offences. The first provision, dealing with breaches of the duty to act in good faith and in the best interests of the company, expressly spelt out the elements of the new offence and introduced an express defence available to directors. The offence modified the mens rea element to now require either actual knowledge or recklessness (previously actual knowledge only). The actus reus element was modified to expressly require serious loss to be caused to the company, or benefit or advantage to be granted to a person other than the company. The express defence covered subsidiaries and companies carrying out joint ventures between its shareholders. The wording of the clause left it up to the director to establish the necessary elements of the defence.

The second provision comprehensively revised the original proposal and abandoned the reckless trading offence as a stand-alone provision. In its place, it introduced an offence of carrying on business in a manner that causes material or serious loss to creditors. The new offence was added to the existing section 380 which deals with carrying on business fraudulently. Unlike the provision dealing with the breaches of the duty to act in good faith and in the best interests of the company, it did not expressly incorporate any new defences.

The changes contained in SOP 249 responded to some of the criticisms raised and partly incorporated the changes recommended in the submissions on the Bill. However, even in its revised (and clearly superior) form, the proposal continued to be met with reservations.

Perhaps the main argument repeatedly raised in opposition to the proposal since its first introduction is the chilling effect it could potentially have on commercial activity. Some warn the change may upset the delicate balance between directors being shielded from personal liability so as to encourage legitimate risk-taking, and at the same time ensuring that truly culpable behaviours can be effectively prosecuted. While SOP 249 went on to clarify the elements of the offences – providing certainty and decreasing the risk of the provisions inadvertently catching innocent conduct – these changes simply were not enough and concerns persisted.

The November revision, in the form of SOP 403, has gone slightly further still, to try and address those concerns. The first offence, dealing with the breaches of the duty to act in good faith and in the best interests of the company, has seen the onus of proof for establishing the defence altered. It is now up to the defendant to raise an “evidential foundation” for the defence, at which point the onus will shift to the prosecution. This approach is consistent with some of the other defences under the Evidence Act 2006, such as exclusion of statements influenced by oppression and improperly obtained evidence.

The latest SOP has also introduced an express defence to the second offence, relating to the carrying on of business in a manner that causes material or serious loss to creditors. It will apply where the director had reasonable grounds to believe that all creditors were identified at the relevant time, and that all of those creditors had consented to the business being carried out in that manner. The same approach has been applied in the new defence with respect to the onus of proof. It will now be up to the defendant to raise the issue on the basis of an evidential foundation, at which point the burden will shift to the prosecution. 

Further changes to the second offence include clarifying the wording to require “one or more creditors” to be affected by the conduct (as opposed to “creditors” used previously), and for the loss to be “serious”. The revised provision also now expressly states it will not apply to compromises with creditors and other similar arrangements under parts 15 and 15A of the Companies Act.

The changes in SOP 403 are another welcome step towards alleviating the concerns raised by the critics of the Bill but yet again it falls short of eliminating them completely. What the two revisions have highlighted, however, is that the proposal is simply not ready to be passed into law. The changes have not been merely cosmetic but have shown a change in direction, both in terms of the substance and the form of the provisions, and some further room for improvement remains.

With that in mind, and given the offences will  potentially apply to every director of the just under 600,000 registered companies and expose them to a maximum penalty of five years’ imprisonment, the need for further careful consideration of the amendment can hardly be overstated. 

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