Christian Chenu

The Federal Court recently handed down an interesting decision that hasn’t generated the media buzz that might have been expected.

The case concerned a well-known business, the Murray Goulburn dairy co-operative (now in liquidation). Murray Goulbourn is famous for owning household brands such as Devondale milk. The case itself flows from a high profile scandal in which Murray Goulburn tried to compel dairy farmers to provide milk at below cost, a story which gained national attention in 2016. And it has now culminated in banning orders for Murray Goulburn’s former managing director and chief financial officer.

The minutiae of what was unimaginatively dubbed the “milk gate” scandal can safely be set aside for the moment. What is of more pressing relevance is the cautionary lessons company directors should draw from this matter.

The officers of Murray Goulburn were put at risk of legal penalties not just because of their own conduct, but also because they allowed their company to contravene the law. This latter basis for liability has come to be known as the “stepping stone” doctrine, and it continues to generate controversy.

Director’s Duties generally

Directors owe duties to their companies.

This is true regardless of whether the company is an ASX-listed behemoth or a private company whose shareholders and directors are one and the same. Although it is not always fully appreciated.

Indeed, directors of small companies should not discount their exposure merely because they are at present also the sole or majority owner. Their obligations at law continue even if the company changes hands or becomes insolvent, at which point incumbent directors may be liable for past conduct to new shareholders, creditors or liquidators.

As fiduciaries, directors have broad duties of loyalty and good faith, and of care and diligence. These duties can be further broken down as follows:

  1. A duty to act with reasonable care and diligence. This is essentially a negligence standard. Arguably, this duty also informs the duty to prevent insolvent trading;
  2. A duty to retain discretions, meaning a director cannot enter into arrangements that bind them to exercise their powers in a particular manner;
  3. A duty to avoid conflicts of interest. This is reflected in related party transactions, disclosure, and misuse of information regimes set out in the Corporations Act; and
  4. Duties to act in good faith, in the interests of the company and for a proper purpose.

A long tradition of expanding liability

Both the Corporations Act and other pieces of legislation set out multiple additional potential heads of liability for directors. These include insolvent trading and mandatory disclosure regimes, as well accessorial liability for knowing-involvement in a company’s contravention of the law.

What has become evident over a number of years is a growing tendency in Australian law to co-mingle company and director liability. Under forms of accessorial or derivative liability, directors share in some of the blame for their company’s actions either as an accessory or, in the case of derivative liability, by virtue of merely being a director of an infringing company. Modern occupational health and safety legislation provides examples of this form of liability.

Watch your step

What is even more controversial is an approach recently pioneered by ASIC and coined by the courts as the “stepping stone” doctrine. Under this approach, a director is said to have breached their duties to their company by allowing it to commit a contravention of the law. In essence, a plaintiff first establishes a violation of the law by the company. This breach is then used as a “stepping stone” to establish that a director, in allowing that contravention to occur (either by conduct, inaction or negligence), failed to discharge their duty of care and diligence to the company, thereby establishing that director’s individual liability for what is fundamentally a corporate – and not personal – contravention.

Although ASIC has been the leading proponent of this argument, there is no reason why the ATO, shareholders or liquidators cannot do likewise, and indeed recent cases support this. Similarly, recent judicial commentary suggests that it may not even be necessary first to establish a corporate contravention – it may be enough merely to show that a company was at risk of breaching the law.

These cases are a timely reminder that directors must remain diligent, as corporate and directorial liability often go hand in hand.

Where to from here?

In the case of Murray Goulburn, ASIC ultimately elected not to frame their argument as a stepping stone case, although in early proceedings they did in fact put that argument. The case is nonetheless a timely reminder for directors that their duties are expansive and any violation of the law by their company may prima facie raise questions of their own personal liability.

It is particularly important that directors of closely held, private companies do not trick themselves into believing that director duties have reduced application for them. Nor can they convene as shareholders and ratify or absolve their own contraventions or negligence. Those breaches could continue to create personal liability for them, particularly if the company has new ownership or comes under the control of creditors and liquidators. They should at all times discharge their obligations in good faith and with care and diligence.

And having paper records that demonstrate that wouldn’t be a bad idea, either.

If this article raises any questions for you, please connect with us on (03) 7035 1300 or and our team will be happy to help you.