The Vines case on appeal

Professor Bob Baxt provides an overview of recent court decisions which affect 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.

The Vines case on appeal – affirming the duties of non-executive directors, but with modifications

The New South Wales Court of Appeal decision in Vines v Australian Securities and Investments Commission [2007] NSWCA 75 was handed down too late for us to comment in last month’s journal. Because of the importance of the decision and the background against which it will be assessed (see comment later on the Treasury Consultation Paper on Sanctions in Corporate Law), we discuss it in detail here.

As reported previously, Austin J had been “severe” in his rulings against Vines and other officers of GIO Australian Holdings. In doing so, he made a number of important observations concerning the standards of care expected of company officers (and directors) and also commented on the particular high benchmark that needed to be attained if an officer or a director wanted to establish that he or she was acting honestly in pursuing his or her obligations on behalf of the company and should be forgiven. Those earlier decisions of Austin J (the second being on penalty) have now come under the spotlight as a result of the critical comments made by all judges in the NSW Court of Appeal. While Chief Justice Spigelman and Justice Ipp upheld some of the findings made by Austin J, they disagreed with a number of others. Santow JA basically disagreed with all of the substantive rulings of Austin J on the liability of Vines, both in the context of the duty of care and in the duty to act honestly.

Because the facts of the case are quite detailed, I will only summarise the most relevant elements the of NSW Court of Appeal decision here. Vines, who had been the CFO of GIO, was charged with breaches of duty of care in ensuring that GIO, the subject of a hostile takeover from AMP Society, provided truthful and accurate responses to various developments relating to its financial statements. The main allegations were that the Part B statement issued by GIO in response to the AMP takeover contained financial statements which included profit forecasts of GIO subsidiary GIO Re which were not “accurate”. Early in the course of the preparation of the Part B statement, a number of natural disasters had occurred around the world and these were partially covered by GIO Re. One in particular, Hurricane Georges, led to a number of major claims being made against GIO Re and GIO. In essence, Austin J held in responding to these natural disasters by providing certain information, Vines had not exercised a sufficient standard of care. Austin J held that the standard applicable under the Corporations Law at the time (section 232 – now replicated for all intents and purposes by section 180(1) of the Corporations Act) meant that it was not necessary for the Australian Securities and Investments Commission (ASIC) to show that the relevant errors amounted to a higher standard of care. Vines challenged this on appeal arguing that the relevant offence was analogous to a criminal negligence standard that should normally apply in a case of gross negligence. It is interesting to repeat what Austin J said in the judgment as this was critical in the review of his findings by the Court of Appeal. Austin J had noted:

“While the point seems open to argument, at least at the appellate level, my view is that to hold that [the] legislature has lowered the statutory standard of care and diligence below the civil standard by rendering the statutory provision a civil penalty provision would be inconsistent with the legislative history of s 232(4) and also with the present case law.” (at [1094] of ASIC v Vines (2005) 55 ACSR 617; (2005) 23 ACLC 1387; [2005] NSWSC 738)

Austin J believed it was necessary to impose the higher standard of care and diligence in the matter. Spigelman CJ rejected this approach. He ruled that the civil penalty proceedings, the subject of the present matter, did not carry with them the stigma of criminal guilt. The potential imposition of penalties – ranging from a fine to a disqualification order – were severe enough for him to question whether the standard applicable in civil liability cases was appropriate. He added these important words:

“The finding of a ‘contravention’ of a statutory provision carries of itself a significant sting, perhaps somewhat higher than a finding of ‘breach’ of a civil duty of care. Such a finding can have a significant effect on the reputation of the individual about whom it is made with, one could expect in the usual case, considerable commercial consequences … At this stage of the application of the statutory scheme, it does not appear to me that the effect on reputation is of a qualitatively different order to a finding of negligence in a civil action, for example, the effect of such a finding in the most closely analogous sphere of professional negligence.” ([2007] at 144-145)

Spigelman CJ then considered the specific contraventions the subject of the decisions of Austin J. Spigelman CJ ruled that a number of the findings of Austin J should be overturned. Importantly, Spigelman CJ believed that someone in Vines’ position could make certain representations about risk assessment by relying on the statements made by senior management of GIO without having to delve into the matters on his own behalf.

However, obligations imposed on Vines’ increased once it became clear that there were warning signals of a more significant nature that he should have taken note of before making statements to the market. So, once it was seen that the auditors of GIO were querying the way in which certain arrangements and agreements were to be assessed, Vines’ obligations increased. Spigelman CJ also accepted the findings of Austin J that Vines had failed to adequately advise the due diligence committee appointed by GIO about certain matters arising out of the potential liability flowing from Hurricane Georges.

Spigelman CJ agreed that once it had been established that the auditors had rejected the reinsurance arrangement known as the ‘American reinsurance agreement’, this created an obligation for Vines to inquire more specifically about the issues involved.

The judgment of Spigelman CJ (with which Ipp JA agreed for the most part) might be seen by some as easing the burdens on officers and persons in the position of the non-executive director to make due inquiry. On the other hand, the judgment of Santow JA will provide a warmer “glow” of comfort for directors and officers. In his view, although Vines had an obligation to deal with profit forecasts in his position, he had to rely very heavily on the work of others who carried the operational responsibility. Vines had done all that he could have done in order to ascertain whether the relevant information was accurate and up to date.

“As CFO [Vines] was clearly operating on the higher plane of corporate strategy and managerial direction with functional responsibility for financial matters … In my view, absent circumstances warranting intervention being brought to his attention, [Vines] was in the position justified in relying upon [certain officers] to provide him with up-to-date information … Nothing [a particular officer] had done was such as should have excited the suspicion of a reasonably prudent chief financial officer in a similar position to [Vines] … Nor do I consider anything in [Vines’] own responsibilities or skills should have given him any heightened sense [that the relevant other officers were] misinforming him.” (see [2007] NSWLR 733-735)

Spigelman CJ disagreed with the majority. He added these useful comments:

“First, the essential starting point in determining whether there has been breach of the statutory standard of care and diligence is to identify what powers are being exercised and what duties discharged, I mean here both legal duties and executive duties assumed. Duties assumed are necessarily shaped by an officer’s on-going legal duties; it would be artificial in the extreme to separate them. Legal duties necessarily encompass the fundamental duty to act in good faith in the interests of the company under its traditional formulation of shareholders, present and future [Santow JA then went on to note that Vines was a person carrying fiduciary obligations which meant that he had to act honestly]. Vines was required to act with care and diligence, that duty necessarily to be accommodated to acting in the interests of the company as a whole. The latter places primary emphasis on the interests of existing shareholders who have risked their capital in the hope of gain, with a proper balancing between short and longer term. That for the present context may properly justify a takeover defence pursued in good faith, directed to achieving the best possible outcome in the interests of shareholders of GIO, as understood at the time …

“Second, unlike the tort of negligence whose gist is damage, detriment does not need to be shown though its absence in a successful prosecution would be rare indeed … Detriment is connected to the officer’s overarching duty to act in the interests of the company, and to balance reasonably foreseeable risk of harm to the company against potential benefits to the company. That this detriment was at risk of occurring or indeed did eventuate, does not of itself establish breach of that officer’s duty:

(a) to act in the interests of the company and its shareholders, or

(b) to exercise the statutory standard of care and diligence.

“Rather that question is answered by reference to what was in the circumstances reasonably foreseeable at the time in order to determine without retrospective hindsight what could reasonably be viewed as a reasonable balance between risk and benefit in the company’s circumstances.

“Third, it must not be overlooked that exposure to risk is a concomitant of business activity aimed at securing benefit for the company and its shareholders, present and future.” (at paragraph 779)

Did Vines act sufficiently honestly to be forgiven? Austin J in his second major judgment involving Vines ruled that although Vines had acted honestly, he was nevertheless not satisfied that in the circumstances he should be forgiven. Under sections 1317JA and 1318 of the Corporations Law (see now sections 1317S and 1318 of the Act) it is possible for the Court to forgive a director for breaches of duty, but Austin J felt that it was not appropriate for him to be excused. In his view, the errors made by Vines (and by his colleagues in relation to the profit forecast) had adverse consequences for shareholders and therefore was a serious matter.

The majority in the Court of Appeal agreed with Austin J. Santow JA felt that the loss suffered by shareholders who had rejected the offer was not significant. It was certainly insufficient to warrant that either there had been a breach of the law (failure of directors to act with honesty) and in any event, Vines had done enough to show that he should be excused.

The case is a classic for possible appeal.

Takeovers panel at risk – but High Court throws out a lifeline

In last month’sEarly Warner we commented on the decision of the Full Federal Court in Australian Pipeline Limited v Alinta Limited and Ors [2007] FCAFC 55 (p16). That decision, as noted in the Early Warner, if not overturned on appeal, would be a very significant blow to the Federal Government’s administration of corporate law.

However, there is light at the end of the tunnel. While the High Court will be shortly hearing whether leave to appeal in Alinta should be granted, it has in the meantime provided some significant guidance in Alberran v The Members of Companies Auditors and Disciplinary Board and Anor (decided in conjunction with Gould v Donald McGarey and Ors) [2007] FCA 23. In this case, which was a unanimous decision of the Full Court of the High Court (although there were two separate judgments – six judges writing one judgment, and Justice Michael Kirby writing a separate judgment), the Court ruled that the powers exercised by the Australian Securities and Investments Commission (ASIC) and the Companies Auditors and Liquidators Disciplinary Board (CALDB) in dealing with issues concerning the disqualification and suspension of liquidators and company directors, did not constitute an exercise of judicial power. Their respective “decisions” were upheld. This ruling will no doubt send an interesting message to the business community in considering future challenges to the operations of the Takeovers Panel and similar bodies on the basis they are exercising judicial power improperly as they are not courts.

The challenge to CALDB’s power to suspend liquidators was brought by two previously suspended liquidators. They argued that their suspension amounted to punishment and could only be imposed by a judge. A similar challenge had been made by a company director to a decision made by ASIC to disqualify him. The six High Court judges upheld the powers of both CALDB and ASIC, indicating that the purpose of suspending or disqualifying liquidators and directors was to ensure that the public was protected and that it was wrong to regard the power as one involving “punishment”.

Although he agreed with the conclusion, Justice Kirby warned that the Government should not be trying to sideline the role of the courts in dealing with similar matters. It was important that the powers of the courts should be maintained. But on this occasion he believed there was no infringement of the constitutional rule that only a court could exercise judicial power.

While the decision of the High Court in this matter deals with a very different issue to the matter involving the Takeovers Panel, it is clear to me that the type of decision being made is very similar. I take great comfort (as do a number of other commentators) that the reasoning of the High Court in these decisions will provide significant comfort to the Takeovers Panel and those on its side in pursuing the appeal in the Alinta matter to the High Court.