Professor Bob Baxt provides an overview of recent court decisions affecting the role and responsibility of directors. Many of the matters examined in the Law Reporter are discussed in greater detail in The Baxt Report published by Thomson Publishing.
How tough will the courts become – particularly in evaluating directors’ duties of care?
Directors of the vast majority of companies now face an ever increasing regulatory burden. New laws are continually being passed, notwithstanding the suggestion that there will be attempts made to cut back on regulatory red tape. Where directors fail to ensure that their companies comply with the relevant laws of the land, just how tough will our courts be on those directors, especially those who do not have any specific obligations or skills in a particular area for the breaches of the law which occur?
Should all directors be held accountable for failures on the part of the company and the board of directors as a whole to comply with relevant laws? Or should the courts be selective in holding directors liable? This particular question was highlighted in a recent prosecution by the Australian Securities and Investments Commission (ASIC) against a number of directors of a group of companies which carried on financial services businesses (ASIC v Maxwell & Ors  NSWSC 1052).
A number of significant breaches of laws relating to fundraising (raising money from the public) and related activities, and episodes of misleading and deceptive conduct, occurred in this case. Maxwell was one of a number of directors of two groups of companies - the ProCorp Group and the Central Development Group. Maxwell, through his company, Business Express Success Techniques Pty Ltd (BEST), acted as a consultant to both groups, and Maxwell and a number of directors and officers of the two groups were prosecuted by ASIC for various breaches of laws. Agreements were reached by ASIC with all of the defendants other than George Nahed, as to the orders being sought from the court against them. Nahed, who was a director and officer of various companies in the ProCorp Group of companies, apparently did not agree with the settlement that had been reached by ASIC. The decision of Brereton J in this case concerned penalties and banning orders being sought by ASIC (all of this is by way of background - none of it is remarkable at all – there have been many similar cases in which banning orders and penalties have been imposed by the courts).
The critical question for Justice Brereton in the context of this note is what standard should be expected of a director such as Nahed who was not in the forefront of the decisions being taken by the board of directors, and who could not be regarded as the main architect of the various schemes and other arrangements put in place. Arguably Nahed had nevertheless allowed the relevant companies to engage in activities which led to breaches of the relevant laws. Should Nahed (who was not represented by counsel in this case) be made personally liable either directly or as an accessory for breaches of various provisions of the Corporations Act (Act) and other legislation? Brereton J held that Nahed should not be held personally liable for breaches of certain of the financial services obligations imposed on the company as these matters were not in his areas of responsibility.
But was Nahed in breach of his duties as a director of ProCorp and in particular the statutory duties under sections 180(1) (the duty of care) and 181(1) (the failure to act in good faith and in the best interests of the corporation)? Was he also responsible for breaches of other laws, by permitting, allowing and participating in the various contraventions committed by those companies? These included the loan agreements which breached certain provisions of the Act publishing advertisements which contained misleading and deceptive information, and allowing the company to carry on a business without holding an appropriate licence.
Brereton J was reluctant to find Nahed guilty of breaches of duty which involved wider obligations than those which he regarded as directly relevant to his position as a director of the company. In this context he noted that Nahed was a little more than 21 years of age when these schemes were promoted; he was a builder and his role in the company was to provide building and construction expertise. Brereton J then went on to provide a useful summary in evaluating the duty of directors to exercise reasonable care and diligence.
“In determining whether a director has [complied with this duty of the relevant section] expressly contemplates the circumstances of the particular corporation concerned are relevant to the content of the duty. These circumstances include the type of company, the provisions of its constitution, the size and nature of the company’s business, the composition of the board, the director’s position and responsibilities within the company, the particular function the director is performing, the manner in which responsibility for the business of the company is distributed between its directors and its employees, and the circumstances of the specific case” (at para 100).
He also noted that directors were not expected to exert a greater degree of skill in carrying out their duties than may be expected from persons of commensurate knowledge and experience. And while directors were required to take reasonable steps to ensure that they guide and monitor the management of the company, they were entitled to rely on others who would have the necessary skills to carry out those obligations. He referred to the fact that the constitution of the company would normally divide the responsibilities between the relevant directors. In endorsing language of Justice Ipp in the case of Vrisakis v ASC (1993) 9 WAR 395, Brereton J confirmed that whilst the duty of care and diligence:
“would be contravened if a director had not exercised a reasonable degree of care and diligence in the exercise of his powers or the discharge of his duties, even if there was no actual damage, that could only be so if it was reasonably foreseeable that the relevant conduct might harm the interests of the company – which means the corporate entity itself, the shareholders, and, where the financial position of the company is precarious, the creditors of the company – and, moreover, that in determining whether the relevant duty had been breached, the foreseeable risk of harm must be balanced against the potential benefits which could reasonably be expected to accrue to the company from that conduct.” (Vrisakis at page 449 and Maxwell at para 102)
The law also recognised that directors could not engage in self-interested dealings – the company’s constitution would normally also prevent that from occurring; but an innocent breach of a common law duty could result in a forgiveness of the directors behaving in a particular way.
But how far does all this go in requiring directors to ensure that their boards and their companies comply with the relevant provisions of the Act? Brereton J recognised that there were cases in which the courts had imposed an obligation on the part of directors to ensure that where there was a clear risk in the company’s activities that certain steps should be taken by the board. But this did not mean that there was “any general obligation owed by directors at large to conduct the affairs of the company in accordance with law generally or the [Act] in particular; … [The obligations of directors] are concerned with duties owed to the company …” (at para 104).
Brereton J reviewed certain cases, and in particular judgments by Justice Barrett in the New South Wales Supreme Court in ASIC v Elm Financial Services Pty Ltd (2005) 55 ACSR 411 and ASIC v Elm Financial Services Pty Ltd  NSWSC 1065 where the judge apparently inferred that the relevant duty “of the directors was to persons invited to invest money by way of loan [in the company], as distinct from [duties owed] to the company”. Brereton J in providing this summary noted that he disagreed with Barrett if that was his conclusion. He added:
“… if a contravention of s 180(1) [of the Act] is to be established, it must be founded on jeopardy to the interests of the corporation, and not to protection of the interests of potential investors (though the interests of investors may be relevant to the interests of the corporation, as potential creditors).” (at para 105)
This may be seen as a very fine line but it is an important distinction. As Justice Brereton later noted, in dealing with both sections 180 and 181 of the Act, the court should not regard these provisions as:
“[providing] a backdoor method for visiting, on company directors, accessorial civil liability for contraventions of [the Act] in respect of which provision is not otherwise made. This is all the more so since [the Act] makes provision for the circumstances in which there is to be accessorial civil liability. Whether there were in this case breaches of the directors’ duties – and, in particular, of their duty of care and diligence – depends upon an analysis of whether and to what extent the corporation’s interests were jeopardised, and if they were, whether the risks obviously outweighed any potential countervailing benefits, and whether there were reasonable steps which could have been taken to avoid them.” (at para 110)
He regarded this distinction as important because the breaches of the fundraising provisions of the Act carried with them criminal sanctions rather than simply civil penalties. And while a different approach might occur in the case of a closely held proprietary company, in which the interests of the directors and the shareholders may be identical, one had to look at the specific situation faced by Nahed.
As the judge gave weight to Nahed’s background, age and his particular skills, it was difficult for him to find that Nahed was knowingly involved in breaching the Act to the extent suggested by ASIC.
The case of course turns on the particular facts and the way in which the evidence was presented. Remember that Nahed was not represented in the proceedings. The judge was therefore concerned to ensure that Nahed’s position was given “a fair evaluation”. It is important, however, to note the judge’s distinction between duties owed to the company and duties owed to the public. If, on the other hand, we were considering the case of a managing director of a company, a member of the risk management committee, or those responsible for ensuring that the company complied with say the Trade Practices Act (TPA) and the directors ignored the steps that were necessary to ensure, for example, that amendments to the TPA were taken into account in the new risk management and compliance program of the company, then this might not only amount to a breach of duty of care by the director – it may also make the director potentially liable, in the event that the company suffered significant financial penalties for breaches of the TPA, in any claim by the shareholders of the company for the directors to compensate the company for the financial penalties imposed on it as a result of it breaching the Trade Practices Act.
This case is an important one. It shows that the courts will continue to exercise a proper discretion and oversight in evaluating the position faced by individual directors in companies. There are clear messages that directors should not take their role lightly, because even if directors escape liability in one sense, they could be caught up in other breaches even though the penalties might not be quite as horrendous as breaches of major provisions of the Act.
Common sense prevails– CAMAC report both sensible and balanced
The long awaited report of the Corporations and Markets Advisory Committee (CAMAC) on Corporate Social Responsibility (The Social Responsibility of Corporations) has finally put to rest (at least for the time being) the question of whether the duties of company directors should be widened to include an obligation to consider ‘social responsibilities of the corporation’. The CAMAC report (published in December 2006) is in my view both sensible and balanced. Despite the concerns raised by Commissioner Terence Cole in his report on the Australian Wheat Board (in which he castigated the Australian Wheat Board for the absence of a culture of compliance within the organisation), CAMAC saw no need to recommend a change to the framework of our legislation.
Prior to CAMAC’s report there was the report of the Parliamentary Joint Committee (PJC) on Corporations and Financial Services in June 2006. In its report, Corporate Responsibility: Managing Risk and Creating Value, the major recommendations were:
- “no change to the provisions concerning directors’ duties.
- social responsibility/sustainability type reporting to remain voluntary.
- various initiatives by governments to impose socially responsible corporate practices, including education, the seeding of a national network and research.” (see p5 of CAMAC Report)
A number of questions were asked of CAMAC in March 2005 by the Parliamentary Secretary to the Treasurer, the Honourable Chris Pearce MP. These questions were:
1. Should the Corporations Act be revised to clarify the extent to which directors may take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?
2. Should the Corporations Act be revised to require directors to take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?
3. Should Australian companies be encouraged to adopt socially and environmentally responsible business practices and if so, how?
4. Should the Corporations Act require certain types of companies to report on the social and environmental impact of their activities?
CAMAC published a discussion paper in November 2005. It was fairly clear from that paper that unless there were some extraordinary issues that were raised in submissions to CAMAC, or by the PJC report, that no drastic change to the law would be recommended. However, as the Cole Report appeared late in 2006 there was always the chance that CAMAC might have been persuaded to issue some recommendations which departed from these expectations.
Thankfully, given the way in which this whole issue is being addressed in different ways by the Australian Securities Exchange (ASX) and by others, the recommendations are both sensible and supportable. In answer to the four questions set out above, CAMAC responded as follows. To questions 1 and 2, CAMAC’s response was:
“[CAMAC] does not support revision of the Corporations Act in the manner referred to in these questions. The established formulation of directors’ duties allows directors sufficient flexibility to take relevant interests and broader community considerations into account. Changes of a kind proposed from time to time do not provide meaningful clarification for directors, yet risk obscuring their accountability.”
CAMAC further noted that specific laws (eg environment protection law) are a better way to deal with specific questions.
As to the third question set out above, CAMAC responded that section 299A of the Corporations Act:
“already provides a general framework for the disclosure of relevant non-financial information. It is an appropriate basis for reporting about environmental and social issues relevant to a company’s business. The Committee considers that the reporting obligations in s299A should be extended beyond listed public companies to all listed entities. Beyond that, the Committee does not see a need at this stage for the Corporations Act to go further in requiring companies or certain classes of companies to report on the social or environmental aspects of their activities.”
CAMAC further noted that the ASX through its Listing Rules and corporate governance issues would further address these matters.
Finally, in response to the fourth question, CAMAC noted that there was much sense in encouraging Australian companies both directly and indirectly to enhance their attitude towards such important issues as environmental protection and related matters. CAMAC noted that it always preferred a ‘light touch’ in dealing with these issues. In its view the government (and it was referring to the Federal Government but of course this applies to all governments) could facilitate or encourage companies in recognising the benefits of appropriate “engagement with the environmental and social context in which [the companies] operate” (page 9 of the CAMAC report).
The conclusions of CAMAC are sound; hopefully there will be less heavy-handed regulation (and this would be consistent with other initiatives being taken); and our courts will continue to provide the necessary ‘guidance’ to company directors as a second note in this month’s Law Reporter illustrates.
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