ASIC’s recent loss against a former managing director turned mostly on a lack of clear evidence about whether he was aware that major contracts had been cancelled, writes Professor Pamela Hanrahan. 

    When the business experiences a material setback, most boards would want to know quickly. This is especially true in listed entities where news of the setback might impact the market for the entity’s securities. Boards expect to hear about material developments through the CEO’s report at board meetings or following a heads-up to the chair between meetings if an important new matter arises.

    If the board and the market are blindsided by bad news, everyone loses. This is why the recent loss by the Australian Securities and Investments Commission in ASIC v Wilson (No 3) [2023] FCA 1009 — a case arising out of the failure by a listed company’s managing director to inform the board that an important customer relationship had been terminated — needs to be put into context.

    What transpired

    ASIC’s case concerned events at former listed company Quintis Limited. Quintis operated sandalwood plantations and derived part of its income from the sale of sandalwood oil. Two Texas-based Quintis subsidiaries had major contracts to supply sandalwood oil to Galderma, a dermatology company owned by Nestlé. Early in December 2016, Galderma indicated to both the subsidiaries that it wanted to terminate the arrangement.

    A termination agreement (with an option for Galderma to reinstate) was executed on 17 December, but the termination was not disclosed to the Quintis board or the market.

    In March 2017, following an adverse report by a US short-seller that led to a drop in the share price, the ASX queried Quintis about (among other things) its previously disclosed major sales contracts. The Quintis response included Galderma in its list of customers out to 2034. On the same day, its managing director, Frank Wilson, resigned. Wilson was the company’s founder and major shareholder and had been on the board in various capacities — including as executive chair and later as managing director — since 2000.

    In May 2017, a journalist learned that Galderma had cancelled its contracts months earlier and contacted Quintis for comment. The next day, Quintis confirmed the termination and the share price fell nearly 44 per cent. A week later, trading was suspended. By November, there were two shareholder class actions afoot and in January 2018, Quintis went into administration.

    Disclosure fail

    ASIC commenced proceedings against Wilson, alleging five separate breaches of his statutory duty of care. It claimed that he was negligent in failing to tell the board that the contracts were going to be terminated, and then that they had been terminated. ASIC also alleged that Wilson “failed to ensure that Quintis did not mislead the market about the termination of the agreements”. These alleged failures were said to “have exposed Quintis to various adverse consequences, including a risk of breaching continuous disclosure requirements” and the misleading conduct laws.

    The matter went to trial before Justice Darren Jackson in Perth in 2021. Evidence was led as to who knew what and when. Justice Jackson found the evidence given by the two key witnesses — Wilson and Dr Paul Castella, CEO of subsidiary Santalis Pharmaceuticals — to be unreliable. The case “posed difficult forensic issues. Which of the two key witnesses was telling the truth, or at least accurately recollecting the key events?”.

    In civil penalty proceedings such as these, the burden of proof rests entirely on ASIC. As Justice Jackson observes, “The burden of proof can become particularly important when the court decides that it is not satisfied as to the case of either of the parties. It may reject both cases. Disbelief of one does not require acceptance of the other. In that eventuality, the court has open to it the third choice of saying that the party with the burden of proving the allegations it has made has failed to discharge that burden.”

    In the Wilson case, ASIC largely failed to meet that burden. Wilson denied that he knew the contract had been terminated and ASIC could not prove otherwise.

    The findings

    ASIC’s case involved five alleged contraventions — one that arose in the lead-up to the termination, one that arose after the contracts were terminated and before the March response to the ASX, and three that arose from the response to ASX. Justice Jackson accepted that, “as the managing director, Wilson had a responsibility to monitor and inform the board about matters affecting Quintis’ commercial position, prospects and performance”, which extended to reporting to the board significant or important matters concerning the subsidiaries. He was also involved in drafting and approving ASX releases on important matters, and it “must have been inherent in that role” that he was to take reasonable steps to ensure that releases were not misleading, including by omission.

    Relevant to ASIC’s first allegation, Justice Jackson found that Wilson had learned in early December that Galderma wanted to terminate the contract and was taking steps to do so. But ASIC’s argument that he should have alerted the board immediately was rejected. His Honour held that there was no duty to inform the board, “when it has not been established that there was anything that the board could have done to prevent that termination or to minimise the harm to Quintis’ interests it would cause”. This is because the duty of care “cannot be defined without reference to the nature and extent of the foreseeable risk of harm... and in my view an officer cannot be said to have failed to act with care and diligence by omitting to perform an act unless it has been established that there was at least a real chance that the act would have reduced or eliminated that harm”.

    The remaining ASIC allegations concerned Wilson’s failure to inform the board and the market (or in the alternative, to make inquiries) after the Galderma contract was terminated. Here ASIC failed on the evidence. It could not prove that Wilson knew termination had occurred. And because of the way the case was pleaded, ASIC was unable to use evidence of what he knew in early December to make its alternate case that a reasonable director would have made inquiries as to the status of the Galderma relationship before responding to the ASX query in March.

    As Wilson was taken (for reasons of proof) not to have known of Galderma’s firm intentions, it was reasonable for him to act on the assumption that if the contract with the subsidiary had been terminated, he would have been told.

    So, the decision turns mostly on the evidence (or lack of it) about what Wilson knew at the relevant time. Despite this, it still provides some useful guidance about what a reasonable managing director should do with information about material commercial developments when it comes into his or her possession.

    This article first appeared under the headline 'Keeping the Board Informed’ in the October 2023 issue of Company Director magazine.

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