In his lengthy judgment in Trilogy Funds Managements Limited v Sullivan & Ors (No. 2) 2015 FCA 1452 (Trilogy), Justice Wigney in the Federal Court has strongly argued that the duties of directors in management investments scheme arrangements are of a higher standard than the duties expected of directors in more “traditional” companies.

    In reaching this view, he found much to be admired in the judgments of Justice Murphy in ASIC v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) [2013] FCA 1342 and ASIC v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (2014) 322 ALR 45 (referred to as the Lewski decisions) notwithstanding the decision of the full Federal Court in Lewski v Australian Securities and Investments Commission [2016] FCAFC 96 (Lewski appeal). It overturned the rulings by Justice Murphy that the directors in the Primus management investment scheme (as it was known) were in breach of their duties under the Corporations Act 2001 (Cth) (the Act).

    The decision of the full Federal Court in the Lewski appeal turned largely on the interpretation of certain sections of the Act in relation to decisions being taken by directors in such organisations. The full Federal Court in the Lewski appeal did not, in my view, contradict the rulings of Justice Murphy on the relevant duties of directors in the Lewski decisions.

    Trilogy involves different questions to those in the Lewski case. In the first place, it was a civil action, not an action brought by the Australian Securities and Investments Commission (ASIC). Secondly, the remedies sought by the responsible entity of the Pacific First Mortgage Fund against the directors and officers involved in the City Pacific Limited organisation, which were responsible for the relevant management investment, were quite different to those sought by ASIC.

    Without going into the full detail of the case, it is sufficient to note that it was alleged that the relevant directors had breached their statutory duties as officers of the relevant companies pursuant to the provisions of section 601FD of the Act. It was also alleged that the directors were in breach of their common law and other statutory duties owed to the company and to the investors in the company.

    Significant sums of money were involved and various significant losses were sustained in the arrangements that were put in place. It was alleged by the Trilogy corporation that the directors had failed to take steps to ensure that the relevant organisation complied with the various provisions of the Act, paying little regard to the contents of the constitution of the management investment scheme arrangements, the compliance arrangements and related matters.

    In a lengthy judgment (over 150 pages) Justice Wigney discussed the facts in detail. At paragraphs 186 and following, Justice Wigney considered the relevant statutory provisions which govern the obligations owed by the officers of the relevant companies. He also considered the duties of the responsible entity in the organisation and running of the management investment schemes.

    Two sets of relevant duties are discussed in some detail. The most significant statutory obligations are that:

    An officer of the responsible entity of a registered scheme must:

    • Act honestly.
    • Exercise a degree of care and diligence that a reasonable person would exercise if they were in the officer’s position.
    • Act in the best interests of the members and, if there is a conflict between the members’ interests and the interests of the responsible entity, give priority to the members’ interest.
    • Not make use of information acquired through being an officer of the responsible entity.
    • Not make improper use of their position as an officer to gain directly or indirectly an advantage for themselves.
    • Take all steps that a reasonable person would take if they were in the officer’s position to ensure [compliance with the Act and the relevant arrangements under the scheme].
    • Justice Wigney also emphasised the need to ensure that no conflict should exist between the interests of the company and the personal interests of the directors involved. He then considered the relevance of section 180(1) of the Act, which requires directors of a company to exercise their powers and discharge their duties “with a degree of care and diligence that a reasonable director would exercise”.

      In that context, Justice Wigney noted the section is almost equivalent to the duty of care under the common law. He discussed a number of recent cases including the Lewski decisions. Having set the background he then added these very helpful words:

      “Whilst the test for the standard of care in s180(1) … is objective, it has some subjective elements. In determining whether a director or officer has exercised reasonable care and diligence, regard will generally be had to the company’s circumstances and the director’s position and responsibilities within the company. The relevant circumstances include: the type of company involved; the provisions of the company’s constitution; the size and nature of the company’s business; the composition of the board of directors; the particular director’s position and responsibilities within the company; the particular function the director was performing; the experience and skills of the particular director; the terms upon which he or she has undertaken to act as a director; the competence of the company’s management; the competence of the company’s advisers; the manner in which responsibility is distributed between the company’s directors, officers and employees and the circumstances of the particular case (at para 201).”

      In support of these propositions he noted a number of cases including the classic decision of Justice Santow regarding HIH Insurance Limited (2002) 168 FLR 253 (generally known as the Adler case).

      Justice Wigney then made some useful further observations: “Directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company. The directors must become familiar with the fundamentals of the business in which the corporation is engaged and are under a continuing obligation to keep informed about the activities of the corporation. Directorial management requires a general monitoring of corporate affairs and policies. The directors should maintain familiarity with the financial position of the corporation,” (citing the decision in ASIC v Healey (2011) 83 ACSR 484).

      Recognising that reliance on others is feasible and should be pursued with care, Justice Wigney also considered to what extent the relevant directors had taken appropriate steps to ensure that those standards were met.

      The next section of his judgment contains a detailed consideration of the earlier cases in which these matters had been examined in some detail. The Trilogy decision predated the Lewski appeal, but Justice Murphy’s comments are, in my view, still highly relevant. Justice Wigney added that the standard of care applicable to an officer under section 601FD(1)(b) will often be higher than the recognition. He noted that the basis for this was that the relevant scheme members were particularly vulnerable to potential conflicts of interest. He added: “Those potential conflicts are: first the potential conflict between the interests of the responsible entity in obtaining fees and the interests of the scheme members; and second the potential conflict between the responsible entity’s interest in obtaining fees and its duty to act in the best interests of the scheme members and give their interest priority”, (at paragraph 211).

      It is unnecessary to delve further into the analysis of Justice Wigney in this case. As indicated earlier, while the rulings in the Lewski decisions have been overturned on the question of liability, it still provides, with the decision in Trilogy, an interesting set of guidelines that still seem to be good law until perhaps the High Court may have a chance to review both decisions, or at least one of them.

      One conclusion that one can safely state is that a very high standard is expected of directors of management investment scheme organisational structures, with a very heavy emphasis on the need to avoid conflicts of interests that can often arise in such organisations.

      ASIC is considerably embarrassed by the decision in the Lewski appeal and is likely to pursue this matter. It is very likely that there will be further litigation in this matter, probably by ASIC seeking leave to appeal the full Federal Court decision to the High Court of Australia.

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