Captain of a sinking ship: Warning to directors who make personal sacrifices for the company’s sake

WRITTEN BY Riley Berry

It seems only logical: your company is in severe financial trouble, so you and your co-directors agree to reduce or even forego your wages payable by the company, to assist its financial position for the time being. But be warned that this logic comes at a cost – it is unlikely that you will be repaid those foregone wages. This is because your employment contract may be deemed to be varied by reason of the doctrine of ‘practical benefits’, which is explored in the case of Hill v Forteng Pty Ltd [2019] FCAFC 105, below.

The Facts

Mr Hill was an employee, director and shareholder of the company, Forteng Pty Ltd (“Forteng”), which was experiencing ongoing financial difficulties. As a result, between the period of January 2013 and December 2013, Mr Hill along with the other directors of Forteng agreed that they would receive reduced or no remuneration as employees, in order to improve the financial position of the company.

A few years later, Mr Hill resigned as a director of Forteng and well after that, Mr Hill brought proceedings against Forteng, seeking to be repaid the amount of his salary withheld between January and December 2013 and unpaid superannuation totalling $154,876.63. Mr Hill argued that Forteng’s failure to repay him amounted to a breach of his employment contract and oppressive conduct, such that he was entitled to relief under section 233 of the Corporations Act 2001 (Cth).

The Decision

The judge at first instance found in favour of Forteng, which was upheld on appeal by the Full Bench of the Federal Court. Ultimately it was held that there was sufficient consideration in the form of a ‘practical benefit’ in order to vary the contract, such that Mr Hill was not entitled to relief or repayment by Forteng.

The Court held that Mr Hill received consideration for his remuneration foregone by way of ‘practical benefits’. This is because his reduced or foregone salary was invested back into the company, thereby:

  • Improving Forteng’s financial position and preventing the company from being wound up;
  • Allowing Mr Hill to maintain his employment with Forteng (as Forteng would have been unable to pay employees, creditors and full director salaries had the directors not agreed to take reduced salaries);
  • Improving Mr Hill’s business investment (by allowing Forteng to retain employees and pay creditors); and
  • Increasing Mr Hill’s chances of being paid dividends in the future.

As such, Mr Hill’s decision to reduce or forego remuneration was to ‘ensure the survival, future growth and enhanced value of Forteng,’[1] for which Mr Hill stood to benefit from indirectly.

The Lessons

  1. Remember that a binding contract or contractual variation can only occur if there is consideration from each of the parties to the contract.
  2. Courts will look to the benefit gained or the detriment avoided when determining the ‘practical benefit’ as consideration.
  3. Courts appear reluctant to invalidate contracts on the basis of insufficient consideration if one party to the contract has made a promise to the other which is of “some substance”.[2]
  4. Whilst a ‘practical benefit’ is more likely to be found where the contract is executory, it is not to say that ‘practical benefits’ will not be found to exist in contracts of a different kind.
    (An executory contract is one where the parties to the contract still have continuing or future obligations to perform such as contracts for goods and services)

If you are seeking advice on any contractual matters, or advice on corporate governance issues, talk to our Business & Commercial team today.

[1] Hill v Forteng Pty Ltd [2019] FCAFC 105 [39].

[2] Ibid [38].

Written by Riley Berry with the assistance of Maxine Viertmann.

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