Legal Lessons from Beyond the Fyre
By Laura Spalding, Lawyer
By now, you might have seen the new documentary on Netflix: Fyre – the greatest party that never happened. If you haven’t seen it, it can be accurately described as the biggest startup fail in history.
The documentary has been rearing its head in many conversations I’ve had recently, and a common question I’ve been getting as a startups lawyer is, how did the executive Fyre team get away with their involvement? What liability did Ja Rule have for his contribution to the events that unfolded. Without knowing the details of the case or jurisdiction, I can’t answer that. However, I can tell you what may have happened if these events had played out in Australia and this article serves as a very timely reminder to all entrepreneurs and contractors working for entrepreneurs about what your legal obligations are to a company, the stakeholders in that company and the wider community.
Time for a quick refresher on director’s duties, and don’t stop reading just because you aren’t a formally appointed director of your company. As the saying goes, if you walk like a duck and talk like a duck then chances are, you’re a shadow or de facto director. Ok, that’s not how the saying goes but read on to find out what I’m getting at.
All company Directors must comply with and carry out certain duties as determined by the Corporations Act 2001 (Cth) (Act), common law (laws made by a judge) and the founding documents (for example the Constitution) of the company with which they work.
Here are the big ones..
Always be aware of the company’s dealings and financial position;
Always be honest and careful in all their dealings, decisions and disclosures;
Not trade whilst insolvent;
Ensure that the company maintains up to date and accurate company records;
Ensure that all company information is dealt with in the correct manner and kept confidential when required;
Always act in the best interests of the company;
Always disclose any conflict that may arise between the interests of the director and the company; and
Not improperly use their position for the gains of themselves or others.
I know what you’re thinking - Billy McFarlane could have really used this article. We can also guess that if any of Fyre’s executive team were appointed directors of the company, they too would have failed to carry out many of the above duties.
Shadow and De Facto Directors
Anyone in a position to make, influence, or guide company or board decisions (with some exceptions) is at risk of being found to be a Shadow Director or De Facto Director and could be subject to these same duties.
A De facto Director typically is someone who acts in the position of a Director. If the Directors of a company are accustomed to act in accordance with your instructions or wishes, you might be a Shadow Director. There is a general exception for people such as legal or financial advisors, or people who are employed by the company to provide guidance on a particular area of expertise.
Without knowing the detailed facts of the case, we could see from the documentary that the executive team and Billy McFarlane took guidance and instruction from Jeffery Atkins (aka Ja Rule). Its likely that the employees of the company viewed him as a Director given his power and influence over the affairs of the company. In an Australian context, this is not necessarily illegal so long as Ja Rule complied with all of the same duties owed by formally appointed directors and listed above.
An Australian example
In 2016 the administrators of Queensland Nickel (‘QN’) released a report implicating Clive Palmer as a Shadow Director of QN and asserting that as a Director, he may have contravened his Director’s duties. Clive Palmer ceased his Directorship of QN in February 2015 prior to his nephew’s appointment as Director and Secretary. In the events leading up to administration, QN was facing financial, workplace health and safety and environmental issues.
The administrators found that Clive Palmer exercised powers in controlling the decisions of the company by expressly approving or rejecting expenditure requests outside of his professional capacity (as a Director of related companies) and by sometimes failing to provide his approval for such requests, controlled QN’s ability to carry on company activities. He also played a significant role in QN’s day to day operational matters such as supplier contract negotiations, ore supplies and employment and remuneration matters.
If found to be a Shadow Director of QN and to have breached subsequent Director’s duties in a court of law, Clive Palmer could face severe penalties and potentially imprisonment. This case highlights the risks that small to large scale family run businesses could be exposed to. If proceedings against Clive Palmer are successful, we are likely to see a rise in litigation against this type of conduct on behalf of creditors making claims against Shadow Directors or even validly-appointed Directors looking to dilute their own accountability.
Directors may be liable for breaching their duties and the penalties can be both civil and criminal. Therefore, it is paramount for directors to be aware of all of their obligations and responsibilities. What is also paramount, is that directors are aware whether they may be considered directors.
If you’re in an executive role in a Company, be aware you may be subject to higher duties and obligations. The ultimate question is who is effectively making board decisions? We recommend identifying those persons, other than professional advisers, who have real influence in or control of, the corporate affairs of the company. It is not necessary that this influence or control should be exercised over the whole field of the company’s corporate activities. Give us a call if you’d like advice on this.
If business isn’t going as planned, call us before resorting to other more, desperate/highly illegal measures.
We are excited to help our clients kick their goals this year, big or small because starting the year on the right foot can make a really big difference. If you’d like to get in touch with us about any of the above, please contact me or the team at Law Squared.
For further information about this article, please contact Laura Spalding, Corporate & Commercial Lawyer at Law Squared.