Directors use business judgment rule successfully in court defence

A recent court case highlighted a rare example of the business judgment safe harbour being used successfully as a plea in response to an alleged breach of the directors’ duty of care. This case affirms key principles of directors’ duties and the business judgment rule, providing commentary on the application of directors’ duties in relation to executive and non-executive directors.

The Federal Court late last year considered alleged breaches of directors’ duties by five directors relating to a merger in Pacific Current Group Limited v Fitzpatrick [2024] FCA 1480.

Pacific Current Group Limited (PAC) brought proceedings against five former directors, alleging breaches of statutory and other duties in a merger with Northern Lights Capital Partners (Northern Lights). The merger involved both companies transferring all assets to a unit trust in exchange for units. Following the merger, PAC reported a net loss of nearly $49 million.

PAC alleged the directors failed to conduct proper due diligence, asset valuations, and obtain necessary shareholder approval, violating PAC's constitution and ASX listing rules. Specific allegations were also made against Andrew McGill, the managing director and CEO during the relevant period.

The Court dismissed claims against the four non-executive directors (NEDs), finding that most of the claims against them were unsubstantiated and concluding that they acted with the necessary care and diligence required of them. Mr McGill was found to have breached his duties by not adequately informing the board about certain matters relating to the merger.

Note: this matter has been listed for further hearing to address outstanding issues such as causation, relief and costs.

Observations

This decision highlights how a director’s skills, experience, position, responsibilities and other factors inform the scope and content of the duty of care and diligence in s 180(1) of the Corporations Act for that director.

Key commentary

The Court defined directors' ‘core duty’ under s 180(1) as taking ‘reasonable steps to place themselves in a position to guide and monitor the management of the company’, necessitating ‘ordinary competence or reasonable ability’. This involves considering various factors when evaluating directors' actions and omissions, including:

• the director’s position and responsibilities;
• the director’s experience and skills;
• the terms and conditions of their directorship;
• the distribution of business responsibilities among directors; and
• the corporation’s employees, information flows, reporting systems, and requirements.

In addition, the Court noted that the business judgment rule (BJR) protects directors from personal liability for honest, informed, and rational business judgments in relation to their duty of care and diligence. The Court found that each of the NEDs had satisfied each element of the BJR when making the decisions under challenge. The findings included the dismissal of an argument that at least one of the decisions of the board was not a business judgment because it concerned a matter of regulatory compliance under the ASX Listing Rules (as to whether shareholder approval was required). The Court characterised the decision as one relating to the transaction, and thus a business judgment, rather than a decision concerning regulatory compliance.

The decision is this case is a rare example of the business judgment safe harbour being successfully pleaded in response to an alleged breach of the duty of care. The ‘business judgment rule defence to an allegation of breach of the duty of care and diligence applies where directors make a decision ‘to take or not take action’ in respect of a matter relevant to the business operations of a corporation.

The Court made the following observations concerning critical elements of the BJR:

• with respect to the requirement in s 180(2)(a) that the judgment be made in good faith for a proper purpose, this is satisfied if the Court accepts evidence from the director that [they] saw the transaction as beneficial to the corporation and [they] believed it was in the best interests of the corporation;
• in relation to the requirement in s 180(2)(c) that the director informs [themselves] to the extent [they] reasonably believe to be appropriate, the reasonableness of the belief should be assessed by reference to:

(a)    the importance of the business judgment to be made;

(b)   the time available for obtaining information and the costs related to obtaining information;

(c)    the director or officer’s confidence in those exploring the matter;

(d)   the state of the company’s business at that time and the nature of competing demands on the board’s attention; and

(e)   whether or not material information is reasonably available to the director.

While the statutory form of the BJR is contained in s 180(2), the Court noted that s 180(1) itself contains a ‘tolerance or margin of appreciation for the business judgment of directors’ in determining whether certain acts or omissions constitute breaches of duty under s 180(1). (This is consistent with the view that in most cases, if a director satisfies the elements of the BJR they will not have breached the duty of care and diligence under s 180(1) in any event.)

Whether directors are entitled to rely upon others under s 189 in their decision making will turn on similar considerations as those that determine the overall standard of care for that individual director. This includes the characteristics of the corporation, the skills and experience of the director concerned and the delegate, and the reasonably anticipated risks associated with reliance.

Where circumstances allow, it is reasonable for a director to rely on advice without independent scrutiny or verification of information upon which that advice is based. Here, the Court observed that NEDs may rely on this principle to a greater extent than executive directors.

Key findings

The Court found that Mr McGill, the CEO, did not properly understand the significance of the risks associated with one part of the business of Northern Lights, a contractual interest in WHV Investment Management Inc (WHV), and attributed liability for failing to take steps to address these risks solely to Mr McGill because the degree or range of skill required of an executive director is higher and broader than that expected from NEDs.

Central to the Court’s decision was the fact that the NEDs were not properly informed by Mr McGill of the problems and risks associated with WHV. The evidence indicated that Mr McGill inadequately investigated the true position of Northern Light’s interest in WHV despite having considerable carriage of the due diligence process and knowledge of its deficiencies. For that reason, the Court also decided that Mr McGill was not entitled to rely on the BJR in relation to decisions concerning WHV.