The James Hardie affair Law Reporter

Wednesday, 01 December 2004


    Can there be a duty of directors to ‘society’? The James Hardie affair.

    Can there be a duty of directors to 'society'?

    The continued frustrations aroused by the inability of the relevant parties involved in the James Hardie matter to find a solution to ensure guaranteed payments to asbestos sufferers, has led to a further recommended change to the law.

    Initially the suggested change was that the law might be altered so that the corporate veil could be lifted in appropriate circumstances to make a holding company liable for the debts (either contractual or tortious) of subsidiaries, especially wholly-owned subsidiaries, within the group.

    The Companies and Securities Advisory Committee (now represented by the Companies and Markets Advisory Committee) (CAMAC) had already reported on this particular issue (in mid-2000) (see Corporate Groups). In my view there are still court and other avenues which can and should be pursued. These have not yet been tested. No change in the corporations law is needed until these matters are more properly evaluated.

    The pressure surrounding the need for a solution has led to a proposal that the law be changed to make directors of companies, especially public companies, responsible to society as a whole in carrying out their duties. This would be expressed, as I understand it, as a positive duty to be owed by directors to society (whoever and however one defines society in this context).

    It is assumed that this would somehow provide a solution to circumstances such as those arising in the James Hardie matter. Such a proposal, with the greatest respect to those suggesting it, is in my view unworkable. If implemented it is likely to be the cause of even greater concern for the community than the existing problem.

    Our corporate law works on the basis that directors owe their duties to the company. The company is in effect the shareholders both present and future. From time to time judges have flirted with the idea that a wider duty may be owed by directors to creditors, employees or other specific groups. Where this has been achieved successfully it has usually been by specific legislation which, rather than creating a positive duty, provided creditors or others the opportunity to sue for certain sums of money etc that might be due to them in relevant circumstances.

    So, for example, for a long time our law enabled creditors to be the prime litigators in cases of insolvent trading. They could sue the directors of a failed company for the debts that the directors had allowed the company to incur while it was insolvent or which had led the company to insolvency. Following reforms to the corporations statute in the early 1990s this right was vested in the liquidator to sue on behalf of all creditors, rather than specific creditors. The UK Companies Act does permit directors to take specific account of the interests of employees in certain circumstances. Indeed, in our Corporations Act, in the context of the takeover scenario, directors are required to identify the impact of a takeover subject to the Takeover Code on employees of the target company. This is both sensible and manageable. One suspects that ASIC in those circumstances could pursue remedies on behalf of particular groups if directors fail to take those interests into account.

    However, this should be contrasted to any positive duty that might be imposed on directors to act on behalf of society as a whole. Who would bring an action in the event that it was alleged that the directors had failed in pursuing such duties?

    If the directors, for example, decided to pursue certain charitable activities (whatever they might be) because they felt it was in the interests of society for the company to give lots of money to a particular cause, could the shareholders then challenge the directors for failing to act in the interests of the company? On the other hand, if a particular group in society felt that it was not being adequately compensated or looked after by the activities of the company (through its directors in whatever scenario one might imagine) who among those members of society would bring the action arguing that the directors had failed in their duty?

    I do not think ASIC would be particularly happy in having to run cases against directors in such circumstances. How would a court evaluate these matters, assuming that one could frame the duty in such positive language as to enable a cause of action to exist?

    It is one thing for the law to allow directors to take into account other interests in carrying out their obligations. This must be framed in the context of directors continuing to observe their primary obligation - the duty to act in good faith and in the best interests, and with care and diligence, on behalf of the company (that is the present and future shareholders).

    It is another matter to require them to diversify their activities in such a way that they sacrifice their obligations to the shareholders.

    If we change the law in this fashion we will be doing great disservice to the limited liability company structure as we best understand it.

    Such a change will quickly undermine the nature of our capitalist system that has brought so much success not only for many companies in our society, but to the community as a whole.

    Our successful companies (and they are by far the vast majority with only a few failing from time to time) not only benefit their many shareholders (and other stakeholders), but the other organisations that they deal with, employees working for them (and other organisations), consumers generally, and of course governments which collect significant amounts of taxes from them.

    We should be very careful before we start to change the fundamental concepts of our law in the manner suggested by those, who quite understandably are frustrated by the James Hardie scenario, but who want to see a quick fix.

    In my view any quick fix will not only not achieve what is intended, but the people who have suffered the pain and suffering in the kind of scenario that the James Hardie case has illustrated will not be the beneficiaries of such a change to the law. ASIC and the government with these amended legislative circumstances in place will both be embarrassed by the inability to enforce the law in the courts, leading to possibly other draconian suggestions. This in turn will lead to further confusion and the destruction of our system as they understand it.

    We should ensure that the current duties of directors are properly administered.

    ASIC should be given the resources to pursue directors who have breached their duty in appropriate cases. Court rules may need to be amended to ensure speedier trials. Penalties for breaching the relevant legislation might have to be increased to create a greater awareness of the positive obligations that are due by directors (but that should not be of too much concern to the great majority of our directors who do behave properly). But we do not need to change the strategic framework of our corporations law, or indeed the common law that sits side by side with such legislation.

    Duties not to act

    for an improper purpose

    The West Australian Court of Appeal confirms the high standards of law in this area

    Both the Corporations Act and the common law dealing with directors and their obligation not to misuse their position has recently been considered by the Supreme Court of Western Australia (in the Court of Criminal Appeal) in the case of Clark v R ((2004) 50 ACSR 592). The facts of the case as set out in the Lexis Nexis Law Report illustrate that in an appropriate set of facts directors charged with a breach of their duty in appropriate circumstances will be properly dealt with by the courts.

    In this case the directors were found to have breached the equivalent of what is currently section 182 of the Corporations Act - making improper use of their position as directors to gain an advantage for other persons.

    The conduct related to agreements executed by the company to retain a certain person as a consultant and to enter into certain options and other agreements. The apparent other party to each of the agreements was either a majority shareholder of the company or another company associated with that particular shareholder.

    It was alleged by the Crown that the directors had engaged in a common enterprise with the other person in order to deprive the company of its assets.

    The matter had proceeded to a jury trial and the two directors were held to be in breach of a provision of the Corporations Law (the equivalent of section 182 of the Corporations Act). They were convicted of offences under the Corporations Law.

    The directors appealed their convictions (which carried the potential of a jail term for both of them) on the basis that the trial judge had erred in admitting certain evidence in relation to the activities, in providing directions to the jury on how they should consider the relevant matters, and that the jury's verdicts were unsound and unreasonable (and that no reasonable jury could reach them.

    In arguing that there could be no breach of the relevant provisions of the legislation, the appellant directors suggested that "even if all of the evidence adduced at the trial, including that of the alleged criminal enterprise, was admissible against [the appellant directors], the evidence in its entirety was insufficient to enable a reasonable jury to conclude beyond reasonable doubt that the appellants were acting dishonestly at the time they approved the resolutions and executed the [relevant documents]." (At para 171.)

    On behalf of one of the directors it was contended that the evidence was "insufficient to exclude the reasonable hypothesis that [that director] was 'naive and/or incompetent, or vulnerable to the influence of others in whom he unwisely reposed confidence'. In relation to the [other director] it was contended that the resolutions and the steps taken to execute documents may have constituted bad judgment on his part but without dishonesty." (At para 171.)

    The Crown responded that the evidence of dishonesty was constituted by an extreme absence of commerciality in the resolutions and transactions, combined with the fact that to the knowledge of the two directors, the resolutions and transactions involved related parties.

    In the Crown's view the failure of the directors "to make any inquiries about the proposed transactions or to seek any independent confirmation that they were in the best interests of [the company] provided a sound basis for sustaining a conclusion that there was sufficient evidence of dishonesty to prove beyond reasonable doubt that each accused was guilty of the offences." (At para 172.)

    Much of the evidence dealt with the commerciality of the transactions and the resolutions. However, the prosecution did not rely so much on the fact that the transactions were uncommercial, but largely on the fact that they were "improper because they were done for the ulterior purpose of benefiting another."

    They further argued that it was unnecessary to show that the transactions were detrimental to the company (although they actually did do so).

    The Court of Criminal Appeal, through Miller J who wrote the major judgment in the case, agreed with the views of the respondents. In his view, the High Court of Australia in R v Byrnes and Hopwood ((1995) 183 CLR 501) made it clear that the provisions of what is now section 182 of the Corporations Act meant that the "test of impropriety and the use of a position as an officer of a company is an objective one and does not depend on an alleged offender's consciousness of impropriety. Rather, it consists of a breach of the standards of conduct expected of a person in the position of the alleged offender by reasonable persons with knowledge of the duties, powers and authority of the position and the circumstances of the case." (At para 174.)

    Justice Miller endorsed the statement of the High Court of Australia (Brennan, Dean, Toohey and Gaudron JJ in Byrnes and Hopwood (183 CLR 514-515) by confirming that "impropriety does not depend on the alleged offender's consciousness of impropriety. Impropriety consists in a breach of the standards of conduct that would be expected of a person in the position of the alleged offender by reasonable persons with knowledge of the duties, powers and authority of the position and the circumstances of the case. When impropriety is said to consist in an abuse of power, the state of mind of the alleged offender is important: the alleged offender's knowledge or means of knowledge of the circumstances in which the power is exercised and his purpose or intention in exercising the power are important factors in determining the question whether the power has been abused. But impropriety is not restricted to abuse of power. It may consist in the doing of an act which a director or officer knows or ought to know that he has no authority to do." (Quoted by Miller J at para 175.)

    Miller J concluded by endorsing the statement of the High Court in Byrnes and Hopwood of the duties of directors, in particular of the public company, in the following terms (at para 176):

    "A company is entitled to the unbiased and independent judgment of each of its directors. A director of a company who is also a director of another company may owe conflicting fiduciary duties. Being a fiduciary, the director of the first company must not exercise his or her power for the benefit or gain of the second company without clearly disclosing the second company's interest to the first company and obtaining the first company's consent. Nor, of course, can a director exercise those powers for the director's own benefit or gain without clearly disclosing his or her interest in obtaining the company's consent. A fiduciary must not exercise an authority or power for the personal benefit or gain of the fiduciary or a third party to whom a fiduciary duty is owed without the beneficiary's consent." (Byrnes and Hopwood 183 CLR at pp 516-517.)

    The directors' appeal was dismissed.

    This case shows that there are some clear guidelines in our case law enabling our courts to deal with these critical issues involving directors' duties.

    Providing proper evidence can be adduced and the regulators mount a prosecution in appropriate time frames, with efficient rules applying in the courts, the law can be enforced without fear or favour.


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