The ASIC v King High Court ruling will affect how lenders manage the way a company extricates itself from financial distress.
When most of us still thought social distancing was something achieved by boarding a large aeroplane, on 11 March, the High Court handed down its decision in Australian Securities and Investments Commission v King  HCA 4. The ruling is important because it clarifies the scope of the definition of “officer” in the Corporations Act 2001 (Cth), which in turn determines who is subject to the onerous statutory duties of care and loyalty imposed by the Act.
The case arose out of events in 2007 and concerned Michael Christodoulou King, who at the relevant time was CEO of listed investment and tourism group MFS Group. An MFS subsidiary, MFS Investment Management (MFSIM), was the responsible entity of a registered managed investment scheme — the Premium Income Fund (PIF) — that held more than $780m of (mostly) retail investors’ money. In that capacity, MFSIM had entered into a loan facility with the Royal Bank of Scotland PLC. In November 2007, MFSIM drew down $130m under that facility, which it passed to another group company that applied the proceeds to pay debts of other MFS entities.
This drawdown constituted, in the words of Judges Nettle and Gordon, “a blatant misuse of PIF’s scheme property”. King had his hands all over the transaction. ASIC commenced proceedings against MFSIM for breach of its duties to the members of the PIF, and against King for his involvement in MFSIM’s unlawful conduct. ASIC also argued that King was an officer of MFSIM and had breached the duties imposed on officers of responsible entities by section 601FD of the Act.
At first instance, ASIC’s action was successful. However, King successfully appealed on the question of whether he was an officer of MFSIM when the transaction occurred, given that he had resigned as a director of MFSIM in February 2007. ASIC’s case was that he remained an “officer” of MFSIM through 2007 because he fell within section 9 para (b)(ii) of the statutory definition as “a person… who has the capacity to affect significantly the corporation’s financial standing”. ASIC argued King had that capacity because he was the CEO and an executive director of MFS with overall responsibility for MFSIM as a member of the MFS Group; and because the executive running MFSIM had reported directly and frequently to him, and customarily acted in accordance with his instructions and wishes in that role.
All in the definition
The Court of Appeal in Queensland had accepted the primary judge’s findings that King acted as the “overall boss of the MFS Group” and assumed “overall responsibility for MFSIM”, but concluded that he was not caught by the definition because any capacity he had to affect MFSIM’s financial standing did not derive from his occupation of an “office” within MFSIM, in the sense of “a recognised position with rights and duties attached to it”. This interpretation significantly narrowed the scope of the definition, and ASIC immediately appealed the question to the High Court.
The High Court rejected the approach adopted in Queensland, concluding that the definition “is not limited to those who hold or occupy a named office, or a recognised position with rights and duties attached to it”. As Chief Justice Susan Kiefel AC and Judges Gageler and Keane pointed out, “By confining the scope of para (b)(ii) to a person who is an ‘officer’ within the ordinary meaning of the term, the Court of Appeal’s construction, in effect, serves to read para (b)(ii) out of the Act.”
The narrow approach was not supported by the words or by the statutory context, history or purpose of the definition. Their Honours observed that, “If the CEO of the parent company of a group of companies is allowed to act in relation to other companies in the group untrammelled by the duties that attach to officers of each of the other companies in the group, shareholders and creditors would be left exposed to an obvious risk. It would be an extraordinary state of affairs if those who actually determine the course of a company’s financial affairs could avoid responsibility for their conduct by the simple expedient of deliberately eschewing any formal designation of their responsibilities.”
Agreeing with the orders made by the plurality, Judges Nettle and Gordon took an expansive approach to applying the definition in large corporate groups where the decision-making powers of group executives may put them in a position to affect significantly the financial standing of every group entity. After discussing modern governance structures and the evolution of the law imposing duties on corporate officers below board level, their Honours accepted that, “there is substantial room for people outside the boardroom to have a significant effect on a corporation and that modern structured corporate groups are often run day to day by key group executives or executive committees of the holding company whose decisions, made on a group rather than an entity basis, are implemented across the various companies within the group”.
The High Court decision concerning King’s status as an officer of the subsidiary was in line with most lawyers’ expectations. A more interesting question is how far the statutory definition of “officer” might extend in future beyond executives and other insiders.
In the appeal, King argued that that para (b)(ii), if applied literally, would capture persons who are, on any realistic view, unrelated to the management of the company’ with external consultants or advisors, bankers, and the Commissioner of Taxation given as examples. The plurality disagreed, describing the concern as “misplaced”. Their Honours said that, “In the case of a person who is said to fall within para (b), questions of fact and degree arise as to whether that person also answers the description of being ‘of’ the corporation in the sense of being engaged, in fact, in the management of its affairs or property.”
But when creditors and counterparties are calling the shots, the line may be crossed. The plurality goes on to note that a person who has legal rights against a corporation as a counterparty to a transaction may be “able to inveigle himself or herself into the decision-making processes of the corporation by means of the mere threat of the exercise of those rights”, in which case the person would fall within the definition. But “that depends on the facts of the case as to the nature and extent of the counterparty’s control of, or capacity to control, the corporation’s decision-making qua management; it does not depend on the counterparty’s legal rights”. And Judges Nettle and Gordon, “do not accept that bankers and other third parties could never fall within the reach of one or more of para (b)(i) (iii) of the definition of ‘officer’ in [the Act]”.
Those questions did not arise directly in ASIC v King “but... lenders managing the way in which a company attempts to work its way out of financial distress may present real issues about the application of these provisions”.
Given the current extraordinary circumstances, the fate of many companies depending on others’ decisions, it may only be a matter of time until this issue is tested.
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