‘Look before you leap!’
Historically, company directors were not treated by the Courts in the same way as other professionals. Accountants and lawyers owed a duty of ‘reasonable care’ towards their clients. But directors did not!
Directors were merely required to do their best (i.e. within the limits of their own personal knowledge or skills). They were not obliged to perform to any objective standard. Nor were they expected to have any requisite skill, training, or experience in managing the company's business. As long as they did the ‘best’ they could, they were not held accountable for the resulting losses caused to a company by their errors.
But ‘the times have changed’. Over the last 30 years or so, the Courts and the legislators have taken a different direction towards corporate responsibility.
Motivated by the ‘spectacular’ demises of several large public companies in the 1980s and 1990s (such as Bond Corporation, Rothwells merchant Bank and Bell Group), these changes were inevitable. The lack of responsibility and accountability displayed by the directors of these public companies was clearly linked to the resulting corporate collapses.
It is, however, fair to say that the duty of care owed by a director to a company has still not reached the level of duty owed by professional advisers (such as lawyers or accountants) to their clients. Nevertheless, they are now subject to an objective standard of care. That standard requires them to act as would an ‘ordinary prudent person’ who has assumed the responsibility of guiding and monitoring the management of a company. No longer can subjective notions of lack of knowledge or lack of experience provide a sufficient defence against liability: see AWA v Daniels (1995) 13 ACLC 614.
Statutory duty of care
Apart from the general law, the Corporations Act has followed suit by imposing a statutory duty of care upon company directors: see section 180(1) of the Corporations Act. In summary, the statutory provision requires a company director to exercise his or her powers or duties with the degree of care and diligence that a ‘reasonable person’ would exercise if they:
- were a director of the company acting in the company’s ‘circumstances’;
- occupied the office or position held by that director; and
- had the same responsibilities within the company as that director.
The question as to breach of duty is determined at the time the impugned conduct takes place. By way of analysis, there are two related questions to be answered. The first question is whether it was reasonably foreseeable that harm or injury would be caused to the company's interests by that conduct. If so, the second question is whether a reasonable person (i.e. in the position of the director) would have conducted themselves in that way, after balancing the risk of harm or injury against the potential benefit expected to be received. This second question is often referred to as the ‘standard of care’.
As in the case of negligence law generally, the statutory standard of care is applied with respect to relevant considerations in the particular case. In the case of a company director, the Court will take account of such considerations as:
- The nature and extent of the company’s business;
- The office or position held by the director and the responsibilities of that position;
- The knowledge and experience expected of an ordinary prudent director in the circumstances; and
- The company’s circumstances (such as the size and type of company, the terms of its Articles of association, and the distribution of responsibilities between its directors and officers).
Although the standard of care has been described as objective, there are clearly subjective components to its analysis. Anecdotally, directors are expected to be generally familiar with the business and financial conditions of the company. They are expected to devote sufficient time and energy to oversee the affairs of the company. By doing so, such effort should allow them to properly discharge their responsibilities to the company (and to its shareholders).
Different defences can be raised in answer to a claim for breach of the particular duty. Each has its own particular scope or limitations, as noted below.
Business judgement defence
A recognised defence to a potential finding of breach of duty arises when the director can satisfy the requirements of the ‘business judgement’ rule: see section 180(2) of the Corporations Act.
Amongst other matters, a director would need to show that he or she has made a business judgement in good faith, for a proper purpose, and rationally believed their judgement to be in the ‘best interests’ of the company. The required elements of the defence need to have existed at the time when the ‘judgement’ was made. All of the requirements need to be established in order for the defence to operate.
As the onus is upon the defendant to establish each of the different elements, it has proven quite difficult to rely upon this particular defence. Indeed, the cases in point present as a ‘beautiful coast, yet littered with shipwrecks’:
- a business ‘judgement’ requires more than a decision made at a board meeting which the director failed to attend – Sheers (2006);
- a ‘rational’ belief requires the identification of facts or matters upon which that belief is based – MacDonald (2007);
- the defence is not available to a director who had a ‘material personal interest’ in the relevant transaction (i.e. which gave rise to the breach of duty) – Adler (2002).
Sections 1317S and 1318 of the Corporations Act provide alternative statutory defences to a breach of duty.
Section 1317S may be specifically relied upon in defence of a claim for a civil penalty. By contrast, section 1318 provides a defence to any civil proceedings for a breach of duty.
Both provisions share the same 2 elements necessary to utilise the defence:
- The director must have acted honestly; and
- the Court must consider the director ought ‘fairly’ to be excused from the breach in the circumstances.
If the defence is available, the Court has a wide discretion as to the appropriate orders to be made:
- The director may be wholly relieved from liability;
- The director may be only partially relieved from liability (for example, for certain transactions); and
- The Court can impose terms upon the orders made as it thinks fit.
Reliance on delegates and third parties
Directors will often need to rely on the company’s employees or contractors to make operational or management decisions. The extent of reliance will depend upon the size or complexity of the company and the location of its different facilities.
For instance, a director might rely on an accountant or a bookkeeper to provide financial information and accounts. Directors might also rely upon a financial planner or stockbroker to assist with investment decisions; or a real estate agent to advise on the purchase or rental of company property.
It is normal for a director to rely on the advice or information received from a third party when making a company decision. However, if a decision later turns out to be the ‘wrong one’ (thereby causing loss to the company), the question of liability arises.
Whether or not it was proper for the director to rely upon third party advice or information in the circumstances will be analysed by the Court. A review is made of the scope of the director’s specific duty, balanced against the necessity and propriety of the assistance which he or she received in the discharge of that duty. Relevant factors to the scope of the duty include: the type of decision made; the input by the director personally; and the reasonableness of reliance upon the information received.
There is also a thicket of related statutory provisions which regulate the operation of a defence based on this ground. Each needs to be carefully considered: for example, see sections 189, 189D and 190 of the Corporations Act.
The provisions are based upon the practice of ‘good’ corporate governance, which is enshrined in the Corporations Act. For instance, any delegation of the director's responsibility to a third party must be recorded in the minutes of the directors’ meetings (unless the company’s constitution provides otherwise): sections 198D and 251A.
Defence of ratification
Under the common law, directors could be excused from a breach of duty to the company if the shareholders ratified the breach. But ratification (i.e. by shareholders’ consent) is not available as a defence to the statutory duty of care under section 180 of the Corporations Act.
The Courts have ruled that such core statutory duties as sections 180, 181 and 182 are public duties. They are not merely private obligations owed to the shareholders. The standard of care expected from directors is thereby ‘irreducible’: Angas Law Services (2005); Forge (2006); Cassimatis (2020).
The remedies available for a breach of the statutory duty are primarily civil in nature. This differs from a few of the other key statutory duties imposed upon directors, such as the duty of honesty or the duty to act for a proper purpose.
In the latter cases, a reckless or intentionally dishonest breach of duty can result in criminal sanctions, including a fine or imprisonment – see sections 184(1), 1311B(4) and Schedule 3 of the Corporations Act.
Nevertheless, the statutory duty of care is a civil penalty provision- see section 180 (1) of the Corporations Act. Therefore, ASIC can seek a civil penalty against the defendant directors. Further, the company or its shareholders can seek compensation resulting from the civil penalty imposed.
By way of a remedy to prevent further breaches of duty, a director can be prohibited from directing or managing any company for a period of years. In the Cassimatis case (noted later in this blog), the directors were found liable for a breach of their duty of care. As a result, they incurred a civil penalty in the order of $70,000 and were both banned from directing or managing a company for a period of 7 years.
Given that the statutory duty of care overlaps with the common law duty of care for negligence, remedies are also available by way of a claim for civil compensation to recover the loss caused by the breach of duty. An action of this type would be brought by or on behalf of the company against the defendant director or directors; also see sections 1317E, G and H.
Cassimatis v Australia Securities and Investments Commission (ASIC)  FCAFC 52
This case is a good example of the interplay between the different directors’ duties owed to a company.
Apart from the duty of care and diligence, the Court was also called on to consider the duties of good faith, acting for a proper purpose, and honesty – see sections 180, 181 and 182 of the Corporations Act.
The case has been analysed in relation to the duty of honesty in another blog in this series. That case- summary related to the original judgement delivered in 2016 by Edelman J. (now a judge of the High Court of Australia).
A number of the requisite analytical components of the duty of care are bound up in the judicial determination. The general question was whether the two directors of a financial services company had breached their duty of care under section 180(1) of the Corporations Act. The specific questions addressed by the Court were:
- Had the Defendants caused the company itself to breach a particular duty under the Corporations Act (namely, to have a reasonable basis for the financial product advice given to their clients); and
- If so, did their conduct constitute a failure to provide reasonable care in the management and control of the company?
The statutory test of liability (noted earlier in this blog) compares the particular acts or omissions by the directors against the degree of care or diligence which a reasonable person would have exercised (i.e. if they have been a director of the same company in the same circumstances, and having the same responsibilities in that capacity).
The findings on the various factors relevant to liability were ‘telling’ against the defendant directors:
- The Defendants ( Mr and Mrs Cassimatis) were the only directors of the company, so they had a high degree of control over its management and direction in the circumstances;
- They both had extensive responsibilities over the company's affairs and were involved in all aspects of its operations.
- Therefore, they were held to have been aware that inappropriate advice was likely to have been provided by their agents to a number of the company’s financially vulnerable clients;
- The company’s agents were found to have breached the specific duty which required a reasonable basis for the advice they dispensed to the company’s clients.;
- A number of their vulnerable clients suffered financial loss, resulting from the advice received;
- As to the directors’ duty of care, it was found that they had failed to take appropriate precautions to prevent the agents from giving inappropriate advice to financially vulnerable clients in the circumstances. In turn, this placed the company at risk of losing its Financial Services licence; and
- By failing to take appropriate cautions to prevent inappropriate advice from being disseminated by their company, the directors effectively placed the company at risk of serious harm to the company's interests. Primarily, the company was exposed to the potential loss of its operating licence because of the misconduct by its agents.
By application of this ‘stepping stones’ approach, the Court concluded that the directors themselves had breached the duty of care. This was so, regardless of whether their company’s agents had also been individually liable.
In effect, the directors had allowed the company's agents to recommend an investment model based on borrowing in order to invest heavily in shares. The borrowing was to be secured by a geared home loan and a marginal loan.
The advice was generally given by the agents in a ‘standard’ format. Therefore, it was provided without any consideration of the personal circumstances of each potential investor. The advice, given to a number of aged or otherwise vulnerable investors, resulted in significant losses to their retirement savings.
The directors attempted to rely upon the common law doctrine of ratification as a defence against the claimed breach of duty. As the sole shareholders and directors of the company, they claimed to be entitled to determine the true ‘interests’ of the company. Those interests did not expand to any ‘disgruntled investors’ in their view.
However, the Court ruled that the doctrine of ratification could not be used to defend the statutory duty.
AWA Ltd v Daniels
- Large losses were suffered by AWA on the foreign currency market.
- The company officer in charge of the foreign exchange currency trading (Kovak) was allowed to operate within the company without any effective supervision.
- Kovak concealed losses in these transactions by making unauthorised loans to cover the losses, which eventually amounted to nearly $50 million.
- During this time, AWA had engaged Daniels, an accountant, to audit the company's accounts and internal processes.
- The audit conducted by Daniels did not result in immediate reporting of the lack of internal controls over Kovak to AWA's directors.
- AWA sued Daniels for negligence in failing to report the deficient internal controls over the foreign exchange trading activities.
- Daniels counter-sued the directors of AWA for contributory negligence.
Had the directors of AWA acted in breach of their duty of care, skill and diligence?
The Court found that the auditors and executive directors were liable in negligence, but the non-executive directors weren’t found to be negligent. It was found that the directors of AWA had failed to put in place an effective internal system to enable them to monitor the proper conduct of the audit. As a result, they contributed to the auditor’s failure to report the irregularities.
Rogers CJ recognised that the exact nature of this obligation would change according to the size and complexity of the company. (That is, the larger and more complex the company, the broader the level of monitoring that will be required). It was also held that the duty of due care and diligence is to be objectively assessed.
However, Rogers CJ imposed a lesser standard on the non-executive directors of the company. Such directors could properly rely on the advice given by the company's internal auditors without breaching their duty. This was particularly important to the finding that the non-executive directors weren’t negligent as they had relied on the advice given by the executive directors.
The case took a ‘first step’ towards increasing the standards expected of company directors in Australia:
- Directors must take reasonable steps to place themselves in a position to guide and monitor the management of the company; and
- Directors must have a general understanding of the company’s business and the effect of the changing economy on that business.
Daniels v Anderson
On appeal, the decision in AWA v Daniels was largely reaffirmed. It was accepted that the executive director had acted in breach of his duty of due care and diligence, but that the non-executive director had not.
The most significant consequence of the appeal decision was to affirm that directors' duties are to be assessed objectively. Ignorance by executive directors was not a defence (whether through inexperience, or by an unreasonable delegation of responsibility for internal problems).
Further, a director is required to inform him or herself about the affairs of the company. There is a positive duty cast on directors to act collectively to manage the company. Inactivity or a failure to enquire will not be sufficient.
ASIC v Rich
ASIC sued several executive directors of the insolvent telephone company, One.Tel, for breaches of statutory duties including that of due care, skill and diligence.
The directors included Rich (who was an executive director) and also Greaves (who was a non-executive director, and chairman of the company).
Greaves argued that he was not in breach of any duty as an officer because his conduct as a non-executive chairman should not be assessed as highly as an executive officer.
Nevertheless, it was noted that Greaves was a very experienced company officer, and was also the chairman of the company's finance and audit committee.
Could a claim for breach of duty succeed against a non-executive chairman (such as Greaves)?
The Court found that Greave's non-executive status did not prevent him from owing a duty of care to the company, particularly considering his substantial responsibility within the company.
His conduct in failing to remain informed of the company's financial position was capable of giving rise to a claim that he had breached his duty of care and diligence. Greaves’ background and experience, in addition to his important role within the company (as finance and audit committee chairman) both contributed to the formulation of the duties he owed to the company.
A reasonable person in his position would have known of One.Tel’s financial circumstances and would have recommended the cessation of its trading. Therefore, Greaves could not rely on his non-executive status to justify a failure to satisfy the basic requirement of remaining properly informed about the company's financial position.
In the case, Austin J also recognised that chairpersons may owe additional responsibilities to other company directors, due to the important role they play in the company.