With more companies failing, Professor Bob Baxt reviews the reasoning used to impose a 25-year ban on a director who did not fulfill his duties of care and diligence or act in good faith.
Behind a 25 year ban
When considering penalties to be imposed in civil prosecutions of directors who have breached their duties under the Corporations Act, the courts have for some time been inclined to be cautious in imposing penalties unless dealing with extreme cases.
By and large, the disqualification periods have been in a modest range when civil offences have been pursued by the Australian Securities and Investments Commission (ASIC).
The most recent high-profile decision concerning disqualification is Vines v ASIC  NSWCA 126 in the NSW Court of Appeal. That court scaled back the range of penalties imposed on Vines after Justice Austin initially handed down quite significant ones.
Of course, where criminal proceedings are being pursued, directors may find themselves facing claims under the relevant Crimes Act, as well as the Corporations Act, and may well end up in prison. These cases are rare although in the current economic climate, with more companies failing, perhaps their number will increase.
It is therefore interesting to read the recent decisions of Justice Hamilton in Australian Securities and Investments Commission v Sydney Investment House Equities Pty Limited & Ors, and in particular the proceedings against a director, Mr Goulding.
In the first decision, ASIC v Sydney Investment House Equities Pty Limited & Ors  NSWSC 1224, Justice Hamilton, on 21 November 2008, found that Goulding had breached the various provisions in the Corporations Act. In ASIC v Sydney Investment House Equities Pty Limited & Ors  NSWSC 144, he imposed a 25-year disqualification period on Goulding for relevant breaches of the Corporations Act.
Such a disqualification period is one of the longest ordered. It is important to understand the nature of the breaches Justice Hamilton ruled that Goulding had committed when considering the penalty.
It is not, however, necessary to delve into much detail of the alleged breaches. Suffice it to say that the relevant companies of the group in which Goulding was a prominent director had gone into liquidation and ASIC had not pursued claims against them. Instead, it pursued claims against individual directors. In this case, the litigation was against Goulding.
ASIC argued that the breaches included Goulding’s failure to exercise the degree of care and skill needed to ensure certain investments and loans to the relevant companies, for which he had significant responsibility, were properly administered. It was also alleged that certain loans involving companies in the group were administered in such a way as to raise serious questions about the carrying on of a financial services business.
Under consideration were whether these were breaches of the Corporations Actas well as breaches of other legislation.
In Justice Hamilton’s view, the lack of attention to the requirements expected of a director in Goulding’s position illustrated that obvious breaches of the law had occurred. In particular, he ruled there had been breaches of the fundamental duties to act with care and diligence, to act honestly and to not improperly use one’s position to gain advantage for oneself or to cause detriment to the company.
Justice Hamilton had to calculate just what steps a director, or directors, had to take in managing companies close to insolvency, especially in a group company context, so as to comply with their relevant statutory duties.
As readers of Company Director will know, a director is required to exercise his or her duties with the appropriate care and diligence, and good faith, for the benefit of the company. The question of how one characterises the company in the context of a factual scenario involving a group of companies, where funds are being shifted around within the group to maintain the financial stability of the company or companies, raises particular difficulties.
Before examining the facts in some detail in a lengthy judgment, Justice Hamilton outlined in broad terms the obligations at law of directors in the context of a group structure such as the one in this case. He was at pains to recognise that when a company is one of a group of companies, each of the companies remains a separate legal entity that has its own interests to which proper regard must be paid (see para 35).
It is useful to extract a few passages from his judgment to illustrate just how particular the courts will be in assessing duties of care and diligence and duties to act in good faith, and whether one has misused one’s position in these circumstances, especially in these difficult financial times.
In considering the duty of care and diligence contained in section 180 of the Corporations Act, Justice Hamilton reviewed previous decisions in which this duty had been considered.
He noted: “One way in which the duty of care owed pursuant to section 180 may be breached is by causing the company to enter into transactions that expose it to risks without the prospect of producing any benefit for the company” (para 28).
While the courts have encouraged directors to adopt an entrepreneurial approach to the way in which they conduct their company’s activities, it is vital that the risks are balanced carefully and sensibly.
In that context, Justice Hamilton also observed that it is important that directors do not become lazy in considering how their actual or personal interests might conflict with those of the company.
He confirmed the very strong line of authority that had been adopted in cases such as ASIC v Adler  NSWSC 171 and Vines v Australian Securities and Investments Commission  NSWCA 75.
Because this case did concern potential conflicts in that Goulding sometimes put his own interests ahead of those of the company, Justice Hamilton revisited the important decision in Wheeler’s case (Permanent Building Society (in liq) v McGee  11 ACSR 260).
In that case, the judge had confirmed that where a director knows that something that is being done would not benefit a company, and has this information by virtue of his or her own knowledge, mere disclosure of the director’s interests and then abstaining from participating in a vote because of a potential conflict was not nearly enough.
Where the director knows that the relevant information is critical to the interests of the company, and where the director should try to persuade the company not to pursue the particular activity even though he or she is personally involved, the director must take positive steps to protect the interests of the company. Failure to do so would amount to a breach of duty.
Another matter which Justice Hamilton emphasised needed to be carefully considered is that where a director is asked to exercise his or her duties in good faith and in the best interests of the company, the director should bear in mind that if the company is insolvent, or its solvency is in doubt, the company which must be at the heart of the decision-making process includes its creditors (para 36).
In particular, after referring to the classic High Court of Australia decision in Walker v Wimborne (1976) 137 CLR 1 at pp 6-7, Justice Hamilton agreed with the proposition put forward in the NSW Court of Appeal decision of Lewis v Doran  NSWCA 243.
In that case, the court noted in the context of a group of companies, “benefits to the company indirectly, which accrue to the company through benefits to the group as a whole, if they are real, may be taken into account” at para 148 (quoted by Justice Hamilton at para 38). The derivative benefits occurring in such a situation are not to be ignored.
This requires directors to engage in a balancing exercise similar to the one applied in section 180 of the Corporations Act – that is, risks can be taken, but they must be very carefully assessed.
Justice Hamilton concluded his review of section 181 of the Corporations Act by noting that the duty to act in good faith and in the best interests of the company should be gauged against the question of “whether an intelligent and honest man in the position of the directors of the company could not have reasonably believed the transaction was in the best interests of the company having in mind the interests of the company’s creditors” (para 41).
He concluded that for ASIC to show there was a breach of section 181, it was necessary “to establish that the director acted with a consciousness that what was being done was not in the best interests of the company concerned”. In this context, in the view of Justice Hamilton, consciousness is equivalent to “knowledge of the facts that make the conduct not in the best interests of the company; is not necessary to establish knowledge that the conduct constituted a breach of the law or was improper” (para 43).
In conclusion, Justice Hamilton endorsed the decision of Justice Brereton in ASIC v Maxwell  NSWSC 1052, noting that directors needed to do their best to ensure companies comply with the law.
Justice Hamilton added: “The duties imposed by sections 180 and 181 of the Corporations Act are owed to the company itself. They are not directly concerned with the obligations of directors to conduct the affairs of the company in accordance with the law. But it has been recognised that causing a company to engage in a course of conduct that breaches the law may involve on the part of directors a failure to exercise reasonable care and skill and a failure to act in the best interests of the company within the meaning of section 181 of the Corporations Act” (at para 49).
He cited with approval the remarks of Justice Brereton in ASIC v Maxwell at para 104 of that case, that a director jeopardises the interests of a company if the director were to “embark on or authorise a course which attracts the risk of that exposure [ie to breach the law] at least if the risk is clear and the countervailing potential benefits are insignificant” (cited by Justice Hamilton at para 50).
In all of the circumstances, and bearing in mind the significant damage that had been caused to creditors of the company by the various actions, Justice Hamilton ruled that the appropriate period of disqualification was 25 years. He referred to the decision of Justice Austin in ASIC v Parkes (2001) 38 ACSR 355 in suggesting that 25 years was appropriate.
The counsel for Goulding argued that this term was unfair when compared with other directors in the company who had been disqualified for much shorter periods.
Justice Hamilton rejected this argument, adding: “Goulding has complained in his submissions that he has been unfairly treated by ASIC and this should be taken into account in fixing the period of disqualification. I am not able to conclude that there has been any substantial unfairness towards him and certainly [not a biased] or a bigoted approach that ‘was and is an obscene abuse of power at the taxpayer’s expense’.”
“On the contrary, a large body of serious breaches of duty have been established against him. Any disadvantage that he has suffered has in general terms been inherent in ASIC discharging its public duty of pursuing him in respect of those breaches.
“If there were any unfairness in his treatment it could not, however, detract from two of the principal factors in the assessment of the disqualification: first, the necessity of protection of the public; and, secondly, the element of retribution and deterrence that is expressed in the disqualification” (para 21).
This is a clear warning that courts are likely to be influenced by the continued noise generated in the media about directors’ obligations, issues surrounding payments being received by directors on retirement from office, and related matters, when regrettably the financial and other difficulties being faced by many companies in the economy may lead to corporate insolvency and loss of significant sums of money by investors.
Professor Bob Baxt AO FAICD(Life) is a partner at Freehills and chairman of AICD’s Law Committee
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