When are Directors Liable for Misleading or Deceptive Conduct, Passing off, Trade Mark Infringement or Unconscionable Conduct?

This is how Federal Court Judge the Honourable Justice Katzmann began her 75-page judgment on the case of IN-N-OUT Burgers, Inc v Hashtag Burgers Pty Ltd, Benjamin Mark Kagan and Andrew Saliba^[1]. Messrs Kagan and Saliba were the sole directors and sole shareholders of Hashtag Burgers Pty Ltd (Hashtag Burgers).

Her Honour’s judgment was later appealed by the Hashtag Burgers, Kagan and Saliba, to the Full Court of the Federal Court (Appellate Court) with a cross-appeal by the IN-N-OUT Burgers Inc (INO Burgers)^[2]. While it is the appellate judgment of Justices Nicholas, Yates and Burley that is of most interest here, it is necessary first to understand the background of the original proceeding.

The original proceeding

INO Burgers commenced legal action against Hashtag Burgers and Kagan and Saliba for trade mark infringement, misleading or deceptive conduct contrary to the Australian Consumer Law (ACL) and the tort of passing off.

INO Burgers is a company in the United States of America with over 300 restaurants in that country by May 2016. Each restaurant sells burgers and familiar accoutrements at fast-food restaurants such as French fries and drinks. Each restaurant was branded with the composite trade mark (INO logo) below.

INO Burgers has registered trade marks in Australia for the INO logo in classes for restaurant services and goods such as hamburger and cheeseburger sandwiches. It also has word marks for IN‑N‑OUT BURGER, PROTEIN STYLE and ANIMAL STYLE for similar goods and services.

Although INO Burgers does not have permanent brick and mortar stores in Australia, since 2012, it has been regularly hosting pop-up restaurants in Australia, which are usually sell-out events.

In May 2016, Kagan and Saliba started personally using the name DOWN-N-OUT (DNO) to promote their restaurant services for the sale of fast food, including burgers, French fries and drinks using the logo below on an Instagram page and a Facebook page.

They started with pop‑up events around Sydney, then a pop‑up restaurant in Sydney, which they announced with a media release entitled “Sydney’s Answer to In-N-Out Burgers Has Finally Arrived”.

In June 2016, Kagan and Saliba used the following logos to promote the DNO restaurants:

It was also relevant that the similarities between DNO and INO Burgers did not end at the logo. Like INO Burgers, DNO featured a “secret menu” and also offered burgers in “ANIMAL STYLE” and “PROTEIN STYLE”.

On 23 June 2017, Kagan and Saliba incorporated Hashtag Burgers and became its sole directors and sole shareholders. Following that, Hashtag Burgers operated a growing number of burger restaurants with the same name, DNO.

Later the name was changed to omit hyphens and appeared as DOWN N’ OUT and later D#WN N’ OUT.

Judgment in original proceeding

In the original proceeding, the trial judge found that Kagan and Saliba and Hashtag Burgers went beyond simply having been inspired by INO Burgers. All three were found to be jointly and severally liable for trade mark infringement, passing off and misleading or deceptive conduct in contravention of the Australian Consumer Law (ACL), specifically:

• before the incorporation of Hashtag Burgers, Kagan and Saliba were jointly and severally liable for this conduct; and
• after the incorporation of Hashtag Burgers, liability rested with Hashtag Burgers, and Kagan and Saliba were knowingly concerned in, and liable for, its contraventions of the ACL that took place after that date. However, her Honour was not satisfied that Kagan and Saliba were also jointly and severally liable with Hashtag Burgers for trade mark infringement or passing off.

The appeal

Hashtag Burgers and Kagan and Saliba appealed against her Honour’s findings that they were liable for trade mark infringement, passing off and misleading or deceptive conduct in contravention of the ACL.

INO Burgers cross-appealed against her Honour’s finding that Kagan and Saliba were not jointly and severally liable for Hashtag Burgers’ conduct of trade mark infringement and passing off while acting as directors and sole shareholders of Hashtag Burgers.

On appeal, the Appellate Court found no reason to depart from the trial judge’s findings that Hashtag Burgers and Kagan and Saliba were liable for trade mark infringement, passing off and misleading or deceptive conduct in contravention of the ACL. The appeal was accordingly dismissed.

On the cross-appeal by INO Burgers, the Appellate Court firstly summarised the trial judge’s relevant findings of fact and conclusions as follows:

1. Kagan and Saliba were the sole shareholders of the company and also its sole directors;
2. they alone made decisions as to its management;
3. they alone were entitled to any profits that might be derived from the company’s torts;
4. the company was the vehicle through which the business they ran continued to be conducted. It was, in effect, their alter ego;
5. there was no evidence to indicate that incorporation of the company made any significant difference to the way the business was run or business decisions made;
6. it was possible to infer that they were not only closely involved in the operation of the business of Hashtag Burgers, but they were also the only people involved; and
7. Kagan and Saliba decided to continue to use the “Down-N-Out” name in its various iterations, which her Honour found “to be the essence of the torts”.

Despite the above, the primary judge found that Kagan and Saliba were not joint tortfeasors in respect of the trademark infringement or passing off by Hashtag Burgers. As noted above, this was the subject of the cross-appeal.

Liability of directors

The Appellate Court applied the authority of JR Consulting & Drafting Pty Ltd v Cummings^[3], citing paragraphs 350 and 351 of that case in relation to determining whether a director of a company will be jointly liable as a tortfeasor with that company:

[350]    … the director must be shown to have directed or procured the tort and the conduct must, clearly enough, go beyond causing the company to take a commercial or business course of action or directing the company’s decision-making where both steps are the good faith and reasonable expression of the discharge of the duties and obligations of the director, as a director. The additional component required is a “close personal involvement” in the infringing conduct of the company and inevitably the quality or degree of that closeness will require careful examination on a case by case basis. That examination might show engagement by the director of the kind or at the threshold described by Finkelstein J in Root Quality at [146] (as earlier discussed) which would undoubtedly establish personal liability in the director or a less stringent degree of closeness (perhaps described as “reckless indifference” to the company’s unlawful civil wrong causing harm), yet sufficiently close to demonstrate conduct of the director going beyond simply guiding or directing a commercial course and engaging in (perhaps vigorously) decision-making within the company as a director.

[351]    Ultimately, the question, on the facts, is what was the conduct of the director said to go beyond the proper role of director so as to descend into the realm of “close personal involvement”?

The Appellate Court also cited paragraph 342 of JR Consulting, in which the Full Court cited Root Quality Pty Ltd v Root Control Technologies Pty Ltd^[4]:

[146]    The director’s conduct must be such that it can be said of him that he was so personally involved in the commission of the unlawful act that it is just that he should be rendered liable. If a director deliberately takes steps to procure the commission of an act which the director knows is unlawful and procures that act for the purpose of causing injury to a third party, then plainly it is just that liability should be imposed upon him.

The Appellate Court went on to say (at paragraph 138) that “plainly enough, to incur personal liability for a tort committed by a company, a director must be acting beyond their proper role as a director.” and applied the statement of Besanko J in a case of Keller v LED Technologies Pty Ltd^[5] where his Honour said that:

…A “close personal involvement” in the infringing acts by the director must be shown before he or she will be held liable. The director’s knowledge will be relevant. In theory, that knowledge may range from knowledge that the relevant acts are infringing acts to knowledge of an applicant’s registered designs to knowledge of acts carried out by others.

The Appellate Court found that Kagan and Saliba were in fact joint tortfeasors to Hashtag Burgers’ conduct following incorporation based on the following findings by the trial judge:

1. they were sole directors of Hashtag Burgers;
2. they alone made decisions as to its management;
3. they alone received the profits derived from it;
4. there was no significant difference between the way that they operated the business before incorporation and the way in which they operated it through the corporate vehicle after it was formed;
5. they were knowingly involved in the company’s wrongdoing.

The Appellate Court found that these five matters taken together demonstrated that Kagan and Saliba had a sufficiently close personal involvement with the actions of Hashtag Burgers as to attract liability as joint tortfeasors and “that their conduct as individuals went beyond the threshold of performing their proper roles as directors”.

ACL liability

A director’s close personal involvement can not only lead to liability as a joint tortfeasor (as was the case with the directors of Hashtag Burgers) but can also give rise to liability under specific provisions of the ACL for compensatory damages and penalties as well as being subject to disqualification as a director. This was recently borne out in Australian Competition and Consumer Commission (ACCC) v Quantum Housing Group Pty Ltd (No 2).^[6]

In the course of its business of arranging investments, Quantum Housing Group Pty Ltd (QHG) sent rounds of correspondence to investors containing purported requirements for their continued access to incentives under the government funded National Rental Affordability Scheme (NRAS). QHG was an ‘Approved Participant’ of the NRAS and, on that basis, had entered agreements with private investors who would purchase properties from QHG in circumstances where the private investors would receive part of the NRAS incentive. The correspondence sent to investors was part of a plan devised by QHG, at a time when Ms Cheryl Howe was QHG’s sole director and sole secretary, in conjunction with a Mr Ashley Fenn. The plan’s main aim was to have the private investors change managers of their investment properties to entities controlled by Mr Fenn, under the guise of these entities being ‘QHG approved property managers’. The representations made to the investors included telling them they would be in breach of their agreement and not entitled to the NRAS incentive if they did not make the switch, which was untrue, and requiring payment of a security deposit to protect their interests, which in fact only served to protect QHG interests.

QHG’s conduct was found to be misleading or deceptive conduct in breach of Section 18(1) of the ACL and to also have made false or misleading representations in breach of Sections 29(1)(l) and 29(1)(m). On appeal, the Full Court of the Federal Court^[7] also found that QHG engaged in unconscionable conduct. Specifically, the appeal Court held that unconscionable conduct for the purposes of Section 21 of the ACL should not be limited to taking advantage of consumers who are in a vulnerable or disadvantaged position, but has a broader scope applying to situations that essentially are against conscience.

Although the appeal is of most importance for its determination of the scope of unconscionable conduct under Section 21 of the ACL, it also makes it clear that a director’s liability, when he or she is knowingly concerned in the conduct of the company, can apply to a company’s unconscionable conduct. This has significance for directors because, under the ACL, where a person is knowingly concerned or otherwise involved^[8] in offending conduct, the Courts’ power to impose pecuniary penalties^[9] and disqualify persons from acting as directors^[10] does not apply to a breach of Section 18 for misleading or deceptive conduct, but they do apply to unfair practices, such as false or misleading representations about goods or services, and, relevantly, a situation where there has been unconscionable conduct.

Ms Howe was found, at first instance, which was not altered on appeal, to have been knowingly concerned in the conduct of QHG. She was required to pay $50,000 in penalties, plus $10,000 towards costs, and was disqualified from managing a corporation for 3 years.

Justice Colvin made note of the following in finding that Ms Howe was knowingly concerned in QHG’s conduct:

1. she was the sole director and secretary of QHG and controlled QHG;
2. she was involved in the implementation and execution of the arrangements for sending the correspondence;
3. she directed and was in control of the employees of QHG for the period of its offending conduct and, in particular, directed the staff who sent out the correspondence; and
4. it was her role to ensure the conduct of the company conformed with the law and appropriate standards of commercial behaviour.

Ms Howe was held responsible and incurred significant penalties even though it was recognised that someone else, namely Mr Fenn, was deriving and benefitting from QHG’s conduct and that Ms Howe did not gain any personal benefit from the conduct.

How this may be relevant to you

The ways in which Kagan and Saliba ran Hashtag Burgers may not be dissimilar to how many small businesses are run. Businesses that wish to emulate the business model of another successful business need to be careful and obtain timely and competent advice to ensure that there is not likely to be an infringement of rights of the other business or misleading or deceptive conduct. Business should, obviously, also be conducted honestly and in good conscience.

Directors of companies need to be aware that if they substantially control a company they may be personally liable for infringements or torts of the company. Directors may also, where they are sufficiently involved in a company, be disqualified as a director or incur penalties in relation to any unconscionable conduct or unfair practices instigated by the company. However, even having regard to the matters listed by the Appellate Court in In-N-Out Burgers, just when the “threshold” between acting merely as a director and being personally involved is reached may not be clear.