CORPORATIONS, duties of directors and officers, division of functions between Board and management, duties and degree of skill required of non-executive directors;Australian Securities and Investments Commission v Healey [2011] FCA 717 (27 June 2011)

June 29, 2011 |

In Australian Securities and Investments Commission v Healey Middleton J found against the directors of Centro Properties Limited.  It is a very long and detailed decision which provides an excellent summary of the obligations of directors.

Facts

ASIC alleged that the approval of the consolidated financial accounts of Centro Property Limited. Centro Property Trust and Centro Retail Trust for the financial year ending 30 June 2007 contravened sections 180(1), 344(1) and 601FD(3) of the Corporations Act 2001. Those contraventions included failing to disclose $1.5billion of short term liabilities of Centro Property and $500 million of Centro Retail by classifying them as non current liabilities and failing to disclose guarantees of short term liabilities of an associated company of about US $1.75 billion that had been given after the balance date (see [24] for a detailed summary of the issues).  Middleton J found that those matters were well known to the directors or, if not well known to them, should have been [11] & [23].

Middleton J found, at [8], the directors failed “..to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them.”  His consideration of the facts with respect to each director is found at ([289][532]).  It is too extensive to comment upon here.  The focus of this post is on the legal principles enunciated by Middleton J.

Decision

Middleton J highlighted the consequences of the breaches and why they are significant when he said, at [10]:

This proceeding is not about a mere technical oversight. The information not disclosed was a matter of significance to the assessment of the risks facing CNP and CER. Giving that information to shareholders and, for a listed company, the market, is one of the fundamental purposes of the requirements of the Act that financial statements and reports must be prepared and published. The importance of the financial statements is one of the fundamental reasons why the directors are required to approve them and resolve that they give a true and fair view.

Principles

Middleton j restated the obligations and responsibilities of a director as:

  • Each director is placed at the apex of the structure of direction and management of a company. The higher the office that is held by a person, the greater the responsibility that falls upon him or her [14];
  • regarding documents signed off, approved or adopted by directors “..before they are adopted by the directors, be read, understood and focused upon by each director with the knowledge each director has or should have by virtue of his or her position as a director” [15];
  • “there is a core, irreducible requirement of directors to be involved in the management of the company and to take all reasonable steps to be in a position to guide and monitor. There is a responsibility to read, understand and focus upon the contents of those reports which the law imposes a responsibility upon each director to approve or adopt” [16]
  • “All directors must carefully read and understand financial statements before they form the opinions which are to be expressed in the declaration required by s 295(4). Such a reading and understanding would require the director to consider whether the financial statements were consistent with his or her own knowledge of the company’s financial position.”[17]
  • a director should acquire at least a rudimentary understanding of the business of the corporation and become familiar with the fundamentals of the business in which the corporation is engaged[17];
  • a director should keep informed about the activities of the corporation[17];
  • a director should monitor the corporate affairs and policies[17];
  • a director should maintain familiarity with the financial status of the corporation by a regular review and understanding of financial statements [17];
  • a director, whilst not an auditor, should still have a questioning mind [17];
  • a director, whatever his or her background, has a duty greater than that of simply representing a particular field of experience or expertise. A director is not relieved of the duty to pay attention to the company’s affairs which might reasonably be expected to attract inquiry, even outside the area of the director’s expertise [18];
  • While directors are entitled to delegate the preparation of books of account each director is expected to “..take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries” [20];
  • for a director considering financial statements “.. is for a higher and more important purpose: to ensure, as far as possible and reasonable, that the information included therein is accurate. The scrutiny by the directors of the financial statements involves understanding their content. The director should then bring the information known or available to him or her in the normal discharge of the director’s responsibilities to the task of focusing upon the financial statements. These are the minimal steps a person in the position of any director would and should take before participating in the approval or adoption of the financial statements and their own directors’ reports” [22];

Standard of proof

In a civil prosecution the appropriate test is the Briganshaw standard.  Further, where the applicant’s case rests on inferences from primary facts its is not sufficient for the circumstances to give rise to conflicting inferences of equal degrees of probability [103].

Financial Reporting

Middleton J endorsed the findings of Austin J in ASIC v Rich where the statutory standard encompasses an objective duty of skill or competence in the reading and understanding of financial material (see [123]).  In practical terms that requires, at [124], directors must:

..have the ability to read and understand the financial statements, including the understanding that financial statements classify assets and liabilities as current and non-current, and what those concepts mean. This classification is relevant to the assessment of solvency and liquidity. Equally, a director should have an understanding of the need to disclose certain events post balance sheet date. It would not be possible for a director to form the opinion required by s 295(4)(d) without such an understanding. It is not suggested that a director could vote in favour of a resolution in support of the required directors’ statements when he did not hold the opinions referred to at all.

While the Act requires the directors’ report be prepared by an entity rather than the directors themselves the report must be made by resolution and signed off by directors.  The directors have a “primary responsibility” for the declaration [128].  Directors can can rely on declarations by the CEO and CFO however Middleton J cautioned against taken such reliance too far, [131], stating, at [134]:

The obligation that a director may have to make a declaration, arising out of his or her performance of a chief executive function or a chief financial officer function is in addition to the responsibility that the director has under s 344 to take all reasonable steps to ensure compliance with the financial records and financial reporting requirements: s 295A(8).

At [139]ff Middleton considered the opeation of Part 2M.3 of the Act, relating to the integrity of annual financial statements.  Directors are responsible for compliance with Part 2M.2 & .3.  Under section 344 directors are not obliged to undertake the acts contained in those parts however under section 295(4) directors are required to form an opinion with all due care and diligence which, at minimum means, at [146], they “..must inform themselves as to the financial affairs company to the extent necessary to form each year the opinion required.”  In determining  compliance under section 344 the court must first determine what steps are required to comply with a relevant provision and then ascertain “what steps reasonably ought to have been taken by the directors to secure such compliance” [150]. It is an objective test.

Section 180 – exercise reasonable care and diligence

Middleton J made it clear that the statutory provision reflects the general law (see [164]) and summarised the directors responsibility thus, at [166] as:

Directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company. A director must become familiar with the fundamentals of the business in which the corporation is engaged; a director is under a continuing obligation to keep informed about the activities of the corporation; directorial management requires a general monitoring of corporate affairs and policies, and a director should maintain familiarity with the financial position of the corporation.

It is an objective standard of care which applies to both executive and non executive directors (see [172]).  In this case the directors responsibilities and duties were outside the realm of operational responsibility and the key issue , at [174], is:

..each director armed with the information available to him was expected to focus on matters brought before him and to seriously consider such matters and take appropriate action. This task demands critical and detailed attention, and not just ‘going through the motions’ or sole reliance on others, no matter how competent or trustworthy they may appear to be.”

In this case ASIC relied on the same conduct to allege a breach of both section 180 and 344.  Middleton considered the interplay between them and found, at [188]:

(a) The directors were required by s 180 to be diligent and careful in their consideration of the resolution to approve the accounts and reports; and

(b) The directors were required by s 344 to take all reasonable steps to secure compliance with the relevant provisions of the Act, and to at least inquire about any potential deficiency in the accounts and reports that they observed or ought by the exercise of the requisite care and diligence to have observed.

Accordingly it is possible to allege contraventions of both sections based on a common factual matrix.

Audit Committee

His Honour found, at [203], that while an audit committee had an important role of monitoring and oversight “..this is not to the exclusion of the role of a director to consider the financial accounts for him or herself. This does not involve a director being familiar with every accounting standard, but sufficiently aware and knowledgeable to understand what is being approved or adopted.” By way of obiter Middleton J suggested, at [206], that “.. it may well be that directors should have a degree of accounting literacy that requires a knowledge of accounting practice and accounting standards.”

Pleadings

His Honour made it clear that a party is confined to its pleadings (see [230][233]) and quoting the High Court in Kirk v Industrial Relations Commission as to the requirement when dealing with a civil offence:

“common law requires that a defendant is entitled to be told not only of the legal nature of the offence with which he or she is charged, but also of the particular act, matter or thing alleged as the foundation of the charge”. The Court continued (at [26] and [28]) to explain that the essential factual ingredients of the offence must be set out, and that, where the essence of the offence is a failure to do something, that which ought to have been done must be set out explicitly and with particularity..”

No case submission and summary judgment

The directors made a no case submission and summary judgment application which were rejected.  Middleton J did not put the directors to their election . When exercising his discretion Middleton J identified the following factors, at [539] as being relevant:

(a) A departure from the general rule can seldom be justified unless adherence to the rule would not serve the ends of justice or convenience;

(b) The Court will have regard to all the circumstances of the case, including the nature of the case, the stage it has reached, the issues involved and the evidence given;

(c) Regard should be had to whether, in all the circumstances of the case, putting the party to its election will result in the most efficient resolution of the proceeding – the Court will consider whether putting a party to its election will lead to the party unnecessarily leading the remainder of its evidence or, conversely, whether not putting the party to its election may result in a real risk that the Court will be required to consider the same evidence twice;.

(d) Departure from the general rule may be justified where the case alleges fraud or dishonesty – in those circumstances it would normally be wrong to permit a defendant to be cross-examined where there really is no evidence against him/her of fraud;

(e) Similarly, in ACCC v Amcor, Sackville J considered that defendants accused of serious breaches of the Trade Practice Act 1974 (Cth) which would render them liable to substantial civil penalties (and also cause potential loss of business reputation), and that the allegations were analogous to a fraud case, were reasons why the defendants should not be put to their election;

(f) Justice Davies in Trade Practices Commission v George Weston Foods Ltd (No 2) [1980] FCA 16; (1980) 43 FLR 55, rejected the fact that the proceeding was a civil penalty proceeding as a ground for not putting the defendants to their election. He nevertheless took into account as a matter to be considered that the allegation is one that calls for a standard of proof consistent with the seriousness of the allegations made.

The departure from the general rule is justified where the fraud is alleged against the moving party [543].

Middleton J found that the rules permitted a summary judgment application could be made even though a trial had commenced (see [548][549]).

ISSUE

While a considerable portion of the decision is a detailed analysis of the facts against the statutory obligations his Honour has set out in clear and precise detail the principles that apply to executive and non executive directors. He has summarised the law which has been extant for some time.  Given the case was involved and hard fought he also had cause to consider and rule upon issues relating to no case submissions, summary judgment and the role of pleadings in civil prosecutions.

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