Director’s liability to indemnify the Commissioner of Taxation under Corporations Act section 588FGA(2)

Director’s liability to indemnify the Commissioner of Taxation under Corporations Act section 588FGA(2)

Commissioner of Taxation v Sims [2008] NSWCA 298, New South Wales Court of Appeal, Beazley JA, Ipp JA and Macfarlan JA, 26 November 2008

(a) Summary

This case was an appeal from the Supreme Court of New South Wales decision by Justice Hammerschlag.  The original proceedings were initiated by the liquidators of Pty Ltd (Newsnet) against the Commissioner of Taxation (the Commissioner) under section 588FF of the Corporations Act 2001 (Cth) (Corporations Act) to recover payments made in respect of tax while the company was insolvent.

Hammerschlag J found that the Commissioner was liable to pay to the liquidators an amount equal to tax payments made by Newsnet to the Commissioner pursuant to Schedule 1 to the Taxation Administration Act 1953, plus interest. The Commissioner sought orders under section 588FGA(2) of the Corporations Act requiring the directors of the company to indemnify the Commissioner for loss or damage resulting from the order to pay the liquidators under section 588FF, including the Commissioner’s legal costs and the liquidators costs that the Commissioner had been ordered to pay, both on a party and party basis.

Hammerschlag J found that one of the directors was liable to the Commissioner for the full amount of the order under section 588FF plus the Commissioner’s legal costs on a party and party basis. The other director was liable for a lesser amount (as she was successful in proving some statutory defences to the claims against her). However, Hammerschlag J found that the directors were not responsible under section 588FGA(2) for the costs of the liquidators. On appeal, the court held that it was empowered to make an order under section 588FGA(2) which extended to requiring the directors to indemnify the Commissioner for the legal costs of the liquidators, so long as those costs were reasonably incurred.

The decision emphasises the extent of potential personal liability under section 588FGA(2) of the directors of a company which makes tax payments while the company is insolvent.  The directors can each be required to indemnify the Commissioner not only for the sum of money paid plus interest, but for all loss and damage to the Commissioner flowing from an action of recovery, including the reasonably incurred costs of the liquidators.

(b) Facts

The Respondents were directors of Newsnet which, at the time of the proceedings, was in liquidation. The liquidators sued the Commissioner under section 588FF of the Corporations Act to set aside tax payments made whilst the company was insolvent. The Commissioner successfully sought the joinder of the two directors of Newsnet, Mr and Mrs Maine, as Respondents to the proceedings and sought indemnity from the directors under section 588FGA(2) for the Commissioner’s loss or damage resulting from the litigation.

(c) Decision 

(i) Decision at first instance

At first instance, in Justice Hammerschlag’s view, the indemnity given to the Commissioner did not extend to the liquidator’s legal costs because the loss must result from an order under section 588FF(1) and that section says nothing about orders as to costs. His Honour reasoned that the ‘order’ referred to in section 588FGA(2) is an order of the kind in section 588FGA(1) which in turn was an order made under section 588FF(1). Therefore, as the loss must result from that order, it cannot extend to costs which the Commissioner must pay due to a further order to pay the plaintiff’s costs.

(ii) The Court of Appeal’s approach to interpreting section 588FGA(2)

The leading judgment was delivered by Justice Ipp who reviewed the authorities that had considered the interpretation of section 588FGA(2). Ipp J concluded, after reviewing the authorities, that the section was ambiguous with regard to whether it empowers the making of orders of indemnity that extend to costs and interest that the Commissioner might be ordered to pay as contemplated by section 588FGA(1).

Accordingly, in order to resolve the ambiguity, his Honour considered the Explanatory Memorandum to the Insolvency (Tax Priorities) Legislation Amendment Bill 1993 which led to the insertion of section 588FGA. The Explanatory Memorandum stated that the position of the Commissioner by virtue of the indemnity in section 588FGA(2) is equivalent to that of a guaranteed creditor.

His Honour also referred to section 588FGA(5) which provides for a deemed guarantee by the directors (jointly and severally). Under section 588FGA(5), his Honour explained that the company is put in the position of a deemed principal debtor and the section provides for a deemed guarantee by the directors of the debts of the company to the Commissioner.

His Honour then explained that under the general law of guarantees it is well settled that: (1) an implied contract arises between the guarantor and the principal debtor whereby the debtor indemnifies the guarantor in respect of monies the guarantor might pay towards the principal debt; and (2) that a guarantor may recover (as damages for breach of the implied contract) damages for its costs incurred in reasonably defending actions brought against it.

While the situation was not directly analogous (as in this case the company is in the position of a debtor and the directors in the position of a guarantor, and the Commissioner is not a deemed guarantor of the directors), Ipp J held that this illustrates that the incurring of legal costs in defending a claim for which another party is liable, in some circumstances, may be properly regarded as “damages” incurred by the defending party.

His Honour then considered what possible loss or damage might fall within the ambit of section 588FGA(2) because it resulted from an order of the kind referred to in section 588FGA(1).  His Honour considered how to best characterise the loss that could “result” from a payment by the Commissioner in accordance with section 588FF(1) (which he considered could only arise from a payment under section 588FF(1)(a)).

His Honour considered that the only possibly conceivable loss or damage that might result from an order under section 588FF(1)(a) to repay money was the costs associated with the reasonable but unsuccessful defence of a claim or interest on moneys ordered to pay.  If this were not the case then in his view section 588FGA(2) would be redundant. This inference is reinforced by the definition in section 9 of the Corporations Act where “result” includes “result indirectly.”

Ipp J considered that the costs the Commissioner was ordered to pay the liquidators resulted indirectly from the order made by Hammerschlag J, requiring the Commissioner to pay the liquidator’s amount of tax plus interest. Had the latter order not been made, his Honour probably would not have made the costs order.

His Honour held that an indemnity can only extend to costs which the Commissioner is ordered to pay which were reasonably incurred. His Honour then considered whether the costs of the liquidator were reasonably incurred and in this case (after detailed examination) he found that they were.

In the alternative, the Commissioner sought orders against the directors of Newsnet in the nature of Sanderson and Bullock orders in respect of the liquidator’s costs. A Sanderson order is an order of a court that the costs of a successful party should be paid directly by an unsuccessful party. A Bullock order relates to a court order against an unsuccessful defendant to pay the costs of the successful defendant where the plaintiff has joined two defendants because of doubt as to which was liable. However, Ipp J in this case held that once the indemnity claim was granted, there was no reason to make any other order.



Co-authored by Brenton Pollard.

Published by SAI Global on behalf of Centre for Corporate Law and Securities Regulation, Faculty of Law, the University of Melbourne with the support of the Australian Securities and Investments Commission, the Australian Securities Exchange and the leading law firms.