Director's Counsel - In defence of directors May 2008

Professor Bob Baxt examines whether further changes to the law governing company directors’ duties are needed.

Do we need further changes to the law governing company directors’ duties? This was the question put to leading barrister and former Federal Court Judge Neil Young QC by the Australian Securities and Investments Commission (ASIC) and which he considered in a paper he presented at ASIC’s Summer School in Melbourne in February 2008. The question was answered quite bluntly by Young in the negative. In effect, his paper was commissioned by ASIC probably as a result of a certain comment made by Tony D’Aloisio, ASIC’s chairman, at an AICD lunch in Sydney in November 2007. At that lunch D’Aloisio suggested that the state of legislation and other regulation, as well as various court decisions, may have discouraged a number of able persons from becoming company directors.

Young’s paper presents a comprehensive legal analysis of certain statutory duties, as interpreted by the courts, which face company directors under the Corporations Act. He also examined a number of important court decisions and canvassed some of the potential issues arising out of those cases. Some of these had already been raised by the Treasury discussion paper entitled Review of Sanctions in Corporate Law, released in March 2007. That paper resulted in submissions from the AICD and individuals like myself to the then Government. Regrettably, however, they were not considered in any detail by the previous Government before it lost office. So it is important to do so now.

Young’s paper did not deal effectively with a number of areas of the law which impact on directors – for example, continuous disclosure and insolvent trading in particular. Nor did it deal with derivative liability.

It is pleasing to note, therefore, that Dr Ken Henry in presenting Corporate Law minister Nick Sherry’s response to Young’s paper at the ASIC Summer School indicated that a task force had been set up by Treasury to ensure that this further work was done. A survey of company directors is being undertaken as part of this work.

In undertaking this review, however, it is important that the Government does not engage in what is primarily a circular argument. What some are questioning – and what Treasury’s discussion paper on sanctions raised more broadly for consideration – is whether the statutory business judgement rule (BJR) contained in section 180(2) of the Corporations Act goes far enough in providing directors, and those in senior managerial positions in companies, with sufficient comfort that they can defend their positions if challenged.

It is vital that we do not limit the debate to the duties under the Corporations Act considered by Young. That may have been the position in Treasury’s sanctions paper. In my view, it is appropriate to ensure that the important question of derivative liability as discussed by the Corporations and Markets Advisory Committee (CAMAC) in its report entitled Personal Liability for Corporate Fault (September 2006) is actioned. As with so many reports prepared for it in the corporate law area (they go back to 2000 when the report by CAMAC on corporate groups was tabled and not actioned), the previous Government was either unable or unwilling to deal with the principal recommendations made.

In this context let me remind the reader of the principal recommendation of CAMAC in its September 2006 report:

“The advisory committee is concerned about the practice in some statutes of treating directors or other corporate officers as personally liable for misconduct by their company unless they can make out a relevant defence. Provisions of this kind are objectionable in principle and unfairly discriminate against corporate personnel compared with the way in which other people are treated under the law.

The encouragement of corporate compliance with applicable laws – which the committee supports – does not justify a general abrogation of the rights of individuals.” [see CAMAC report pages 8-9]

This is a very important issue which is now in need of urgent consideration. It is understood that it has been referred to the Council of Australian Governments (COAG).

In addition, we should also recognise that since the Treasury’s sanctions paper was published, the obligations facing directors in other areas – namely insolvent trading and continuous disclosure – have become even more significant and prominent. In this context, Vines v ASIC [2007] 62 ACSR 1, and Hall & Ors v Poolman & Ors [2007] NSWSC 1330 are important cases – they were only briefly discussed in Young’s paper.

In Hall v Poolman, Justice Palmer generously applied for the first time to my knowledge a discretion to forgive directors for breaches of their duty not to engage in insolvent trading by using s1318 of the Corporations Act (see also s 1317S of the Act). The difficulties thrown up by the questions he had to consider illustrate quite effectively the need for this particular area of the law to be considered more carefully. A similar argument can certainly be made about continuous disclosure, especially in the current difficult climate.

Cases discussed by Young did result in correct decisions by the courts on the basis of the facts as set out in those cases. But in my view, that is not the real issue. There is no argument that ss180 – 184 of the Corporations Act should continue. There is already a strict regime impacting on directors who do not engage in appropriate due diligence, who allow a conflict of duty and interest to occur or who rely inappropriately on officers who do not have the knowledge and skill to deal with important issues facing the company directors.

But, in the more difficult cases, it is useful to consider the dissenting judgement of now retired Justice Kim Santow of the NSW Court of Appeal in Vines. In that case, he did not find that Vines was liable for certain breaches – in that sense he disagreed with the other members of the court. He was also more generous in dealing with penalties. Such a decision shows that there is room for serious disagreement in cases of this kind and there should be opportunities for the matter to be further considered.

It is not a black and white issue in many cases at all. It is particularly not a black and white issue when we remind ourselves of the fact that in many situations we are dealing with cases where the litigation is occurring some years after the particular activities or judgments were taken by the relevant directors. In that context, may I remind readers not to ignore the comments made by Justice McDougal in particular in Ingot Capital Investments v Macquarie Equity Capital Markets (No.6) (2007) 63 ACSR 1 where he criticised the uncritical use of hindsight to assess liability.

We should also keep in the forefront of our attention the comments made by a number of judges that entrepreneurialism must be encouraged and not chilled as we move forward. In that context, even the majority of the NSW Court of Appeal in finding against certain directors in the famous AWA case on appeal (Daniels v Anderson (1995) 37S NSWR 438) emphasised the importance of entrepreneurialism as a vital element in assessing directors’ duties. These comments are particularly relevant:

“The courts have recognised that directors must be allowed to make business judgments and business decisions in the spirit of enterprise untrammelled by the concerns of [conservatism]; any entrepreneur will rely upon a variety of talents in deciding whether to invest in the business venture … Great risks will be taken in the hope of commensurate rewards. If such ventures fail, how is the undertaking of it to be judged against an allegation of negligence by the entrepreneur?”’ (1995) 13 ACLC at pages 662-663.

It is timely that the Government and Treasury have indicated a willingness to revisit these matters as a matter of some urgency. Hopefully, we will see a generous and proactive debate on the relevant issues that ensures directors are given appropriate opportunities to defend their actions in appropriate cases. It is important to remember that in establishing these defences, the burden will remain on the relevant director. The existing BJR has been almost impossible for directors to establish. Indeed, there are no reported cases in which it has been successfully applied. It is my view that we have nothing to fear in introducing a broader defence such as the one outlined in Treasury’s sanctions paper, but widened to pick up other areas of the law such as continuous disclosure. The defence in each case will have to be established by the director seeking an appropriate defence against allegations of breaches of duty. That will be a very difficult task. But as Vines and Poolman indicate in their own way, in the appropriate case the task will not be an impossible one.