Directors Duties and Financial Responsibilities
UNIVERSITY OF NEW SOUTH WALES Faculty of Law Directors Duties and Financial Responsibilities Tuesday 26 November 2002
Introductory Remarks by Justice R P Austin, Supreme Court of New South Wales
It is a pleasure for me to be here and to open your seminar, on such topical subjects. Yesterday the organisers sent me two of the four papers, dealing with the financial reporting responsibilities of directors and their duties in the context of corporate takeovers. Both of them are thoughtful and thorough presentations which you will find interesting and enlightening. You will also hear papers on the duties of directors of listed companies under the continuous disclosure regime, and on their duties when the company is in financial distress. I have not seen those papers and cannot comment on them.
I have responsibility for the Corporations List of the Supreme Court, which I share with Justice Barrett. The Court is by a substantial margin the busiest court in corporate litigation in this country, accounting for over 40% of reported decisions. The Registrar in Equity processes a huge volume of winding up applications each week, and in the Corporations List administered by either Justice Barrett or me, there are on average around 15 applications per week. Additionally, we case manage larger corporate matters, which include quite a few civil penalty cases conducted by ASIC. Three large civil penalty cases are coming up for hearing in the not too distant future.
In those circumstances, I thought you might be interested to hear from me some comments on those aspects of the law of directors' duties that are currently of concern in corporate litigation in the Supreme Court. These are only my own remarks. The perspectives of Justice Barrett and the other Judges of the Equity Division, all of whom adjudicate corporate proceedings from time to time, may well be different.
I shall not be able to express opinions on matters currently before the Court, for obvious reasons. I shall, however, raise some questions that are pertinent to current litigation.
I do so with a purpose in mind. The Court is being asked to deal with a multitude of matters upon which statutory and case law do not provide clear direction. It is my belief that legal scholarship provides the surest foundation for a judge in these circumstances. The areas that I shall touch upon are areas where there has been some scholarly work, but I believe much more could be done. I make this point in a self-interested way. Legal scholarship is needed to assist the Court to perceive the way forward on important issues of corporate law. I encourage those of you who write seminar papers, or who listen to them, to consider whether you might apply your skills in legal scholarship to answering some of the questions that I shall raise.
I shall make some remarks about problems in the law of directors' duties, civil penalty proceedings, and (briefly) some aspects of insolvency litigation.
Directors' duties
Section 659B limits the jurisdiction of the courts in a manner that prevents the combatants from applying for relief during the bid period. The full scope of that privative clause has yet to be settled, but as a practical matter it has virtually eliminated tactical takeover litigation. Complaints about the conduct of the target board during the bid period are now brought to the Takeovers Panel.
However, the Court still has plenty of opportunities to develop the general and statutory law of directors' obligations.
The statutory duty of care of directors and other officers of the corporation remains a fairly mysterious area. The standard set by s 180 (1) refers to the degree of care and diligence that a reasonable person would exercise, but the section demands that the reasonable person be placed in a corporation in the corporation's circumstances, and that he or she must occupy the office held by the defendant, with the very same responsibilities that the defendant had as a director or officer.
This blend of the subjective and the objective leaves room for debate as to how much of the defendant's personal circumstances should be taken into account. The legislature has, somewhat self-consciously, refrained from imposing a standard of skill, but the wording seems to leave room for argument that the individual skills of the defendant, especially his or her financial skills, can be taken into account in determining whether there has been a breach of the statutory duty. This is because individual skills might affect the "responsibilities within the corporation" that have been allocated to the defendant.
As the Hon Andrew Rogers QC recently remarked in a presentation to the Chartered Institute of Company Secretaries, the Court has yet to decide whether participation on a board committee affects the statutory and general law liabilities of a company director. By taking an appointment on the audit committee, for example, the director arguably undertakes (sometimes for additional remuneration) additional work, suggesting additional responsibility. On the other hand, if the director is a non-executive director, the nature of his or her office arguably limits the responsibility that can be fairly attributed to the director, even as a member of a board committee.
Allied to that problem is the question whether the director who does not serve on the relevant committee is entitled to rely upon the committee and follow the committee's recommendations with its sphere of responsibility, without further inquiry. The AWA case told us that directors must approach their work with an inquiring mind, but it may be hard to see what inquiries might reasonably be expected of the director who receives a competent report by a board committee on a complex matter. Of course, the report must on its face be a competent one, where the reasoning and conclusions of the committee are clearly set out, and the scope and content of the committee's work program is explained.
I expect that the answers to these questions will evolve fairly gradually, through the traditional mechanism of judicial decisions. However, the volume of corporate litigation involving the duty of care of directors has increased over recent times, and that trend is likely to continue. This is because questions of breach of the duty of care typically arise after a corporate collapse, and we have had our fair share of those recently. Additionally, ASIC is now using its powers under the civil penalties provisions of the Corporations Act quite frequently. As I have said, there is a substantial number of civil penalty cases, including some very large ones, in the Court at the present time.
It must be remembered that allegations of breach of the directors' duty of care are frequently combined, in corporate litigation, with allegations of breaches of other statutory and general law duties. Apart from the special statutory duties of directors for a misleading prospectus or takeover disclosure document, we must bear in mind the general provisions concerning misleading and deceptive conduct, found in the Commonwealth Trade Practices Act and the Fair Trading Acts of the States, as well as (with respect to financial products and financial services) the ASIC Act. We should specially note the ancillary liability of those knowingly involved in the contravention.
Where the conduct complained of includes some information released by the directors, such as a statement to the market or an information memorandum, there is likely to be an issue as to whether that statement was misleading and if it was, whether it has caused loss. The Australian Stock Exchange announced over the weekend that it will require directors to provide "management discussion and analysis" reports. Those reports will be another occasion for the publication of potentially misleading information and therefore potential liability for directors. Once the misleading character of the information, and the causal relationship between it and the plaintiff's loss, are established, questions of materiality and negligence are irrelevant. In a market context, if the misleading information has caused a substantial price movement (or prevented it), the damages could be very large.
The law of directors' duties has not kept place with the burgeoning literature of corporate governance. One of the general questions confronting the Court is whether, assuming they are admissible as evidence, papers by expert corporate governance committees such as those chaired by Sir Adrian Cadbury and Mr Henry Bosch should be allowed to influence the Court's determination of legal liability. Generally the pronouncements of these committees are directed to best practice rather than legal obligation, but they may nevertheless reflect changing community standards which might have an impact on the liability of directors. It has often been said that community standards and expectations have changed, and correspondingly the law has changed, since the Marquess of Bute's case. May the Court refer to the reports of corporate governance committees as an indication of current community standards?
Recourse to corporate governance literature might affect such issues (at any rate, in the case of a large listed public company) as
· whether the law should now accept that there are different standards for executive and non-executive directors;
· whether membership of a board committee such as the audit committee should carry additional legal responsibility;
· whether the chairman of the board has greater legal duties than other members of the board.
Civil penalty proceedings
One of issues that the Court is required to confront quite frequently relates to civil penalties cases. These are cases in which ASIC, as plaintiff, alleges breaches of duty by the defendant, and seeks a variety of remedies including an order that a civil penalty be paid, or a compensation order, or a banning order. The Adler and Whitlam cases are recent examples.
The significance of civil penalty proceedings can hardly be overstated. This is especially so now that the civil penalty regime has been expanded to apply to the market offences provisions of the Corporations Act, such as those relating to continuous disclosure and insider trading.
From a lay perspective, it is easy to confuse a civil penalty case with a criminal prosecution. The Court's decision often leads to a headline in the press, such as "Mr X banned for 20 years" or "Mr Y banned and fined". Press reports can read very like reports of a criminal verdict.
The problem for the Court relates to whether, or more precisely to what extent, these cases are to be treated purely as civil cases, and to what extent analogies from the criminal law should be applied. The problem is all the more acute for a court like the Supreme Court of New South Wales, where ASIC civil penalty cases are allocated to the Equity Division, notwithstanding that Equity abjures penalties.
Amongst the questions that have recently been, or are being, considered, which seem to depend upon whether civil penalty cases should be given a "quasi-criminal" character, are the following:
1) Is the standard of proof more demanding than the balance of probabilities standard, and if so, how precisely should it be formulated, and in particular, should there be any special statement to replace the Briginshaw formulation?
2) Should the rule in Jones v Dunkel be applied in the same way as it is applied in other civil cases, or should there be a stricter limit on inferences to be drawn from the failure of the defendant to call a person to give evidence?
3) In dealing with civil penalty cases, especially where interlocutory injunctive orders are sought, should the Court treat ASIC as a special plaintiff?
4) Should the "quasi-criminal" nature of the proceedings affect the nature of the particulars that ASIC should be required to provide, and lead to the Court limiting ASIC at the trial to the case so particularised?
5) Should the Court give the usual directions that it makes in civil proceedings, requiring the defendant to file and serve affidavits according to a timetable prior to the hearing?
Insolvency
The context in which insolvency becomes an issue is of great importance in deciding what has to be proven, and to what standard. Where a question of insolvency arises under Part 5.7B of the Corporations Act, various presumptions may arise. In the context of directors' liability for insolvent trading, much depends upon objective and subjective standards of knowledge of insolvency, from which the concept of insolvency cannot readily be extracted.
It is arguable that a case of directors' liability for insolvent trading can also be pleaded in negligence. If it is, and the contention is that the directors allegedly failed to act when there is evidence pointing to insolvency, a question may arise as to the application of a statutory limitation period. The law seems to be that the limitation period begins to run when the directors should first have realised that the company was insolvent and should therefore have taken remedial action. That issue was the subject of a recent contest in the Court.
One of the perennial difficulties in cases where insolvency is an ingredient is this: how does one prove insolvency? Sometimes the issue is beyond doubt. At the relevant time, the company's balance sheet shows a net deficiency, and an inadequate cashflow to service creditor demands. On other occasions, the question can be very complicated. For example, in a construction business of any degree of sophistication, insolvency may depend upon the validity of variations, the application of obligations concerning retention monies, the contractual effects of non-completion, and the interaction of various building contracts to produce an overall picture.
Frequently the parties to a contested case in which insolvency is in issue seek to tender and rely upon the reports of accountants. The admissibility of expert evidence of that kind was explained in Quick v Stoland, especially in the judgment of Justice Emmett, but the application of the principles is not always easy. In a case where insolvency depended upon facts within a narrow compass, all of which were before the Court, it was recently held that expert evidence was inadmissible, but in a case where the question related to the solvency of a substantial construction company, expert evidence in the nature of fully reasoned reports was allowed.
In cases of directors' liability for insolvent trading, not much has changed, as far as I can see, since the celebrated decision in Friedrich's case. That means, of course, that the law remains as significant for directors as ever it was.
Conclusions
Most of you in this audience are advisers. Directors need competent and thorough advice, because the law is not self-evident and in some cases, directors who subjectively believe that they have acted "innocently" might nevertheless find themselves liable for breach of duty. The seminar therefore raises some very important issues. I am confident that you will benefit from it and through you, your clients and the community will also benefit.
I shall hand the microphone back to the chairman, who will introduce the first speaker.
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