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Focus: Corporate Governance – March 2003

Chairman's duties under the spotlight

In brief: Contrary to press commentary about Justice Austin's decision in the ASIC v Rich preliminary proceedings, the court did not hold that chairmen now have a duty to ensure that only financially competent people are appointed finance directors, that all statements to the ASX are accurate, and that a company takes reasonable steps to ensure that it maintains sufficient cash reserves to continue its existing operations. As Partner Richard Alcock and Senior Associate Carl Bicego report, the court's substantive response on directors' duties is yet to be revealed.

The 24 February 2003 decision by Justice Austin in the New South Wales Supreme Court did not need to rule on ASIC's expansive assertions and dealt only with a preliminary application by Mr Greaves for summary dismissal of a statement of claim. In dismissing Mr Greaves' application, the court was required only to consider whether ASIC's statement of claim disclosed a reasonable cause of action against Mr Greaves for breach of his duty of care and diligence.

ASIC has brought proceedings against the executive directors of One.Tel (Jodee Rich, Brad Keeling and Mark Silbermann), contending that each breached their statutory duty of care and diligence under section 180(1) of the Corporations Act. Proceedings were also brought against the non-executive chairman, John Greaves, with ASIC submitting that Mr Greaves' duties were greater than those of the other non-executive directors.

Mr Greaves, in turn, filed a motion seeking to strike out the proceedings against him on the basis that the extra duties that ASIC contended he was subject to were not known at law, and that there was therefore no reasonable cause of action disclosed against him.

Justice Austin dismissed the application by Mr Greaves, finding that a reasonable cause of action had been disclosed against Mr Greaves. Obviously the judgment on this application is only a first step in the proceedings, but it promises to shed light on two key provisions introduced by the Federal Government's CLERP reforms in March 2000:

  • the re-formulated director's duty of care and diligence; and
  • access to the new 'safe harbour' defence provided by the 'business judgment rule'.
The director's duty of care

In making his finding, Justice Austin reviewed the recent statutory reforms to the duty of care and diligence. In particular, he compared the CLERP reforms to the previous law, which provided for an assessment against the degree of care and diligence that a reasonable person would exercise in a like position in that corporation's circumstances.

In the mid-1990s, in Daniels v Anderson (the appeal to the AWA v Daniels decision), the NSW Court of Appeal imposed a minimum objective standard applicable to the position of director that applied equally to executive and non-executive directors. Against the concern that this would fail to recognise the personal circumstances and responsibilities of some directors, the CLERP amendments altered the test by providing under section 180(1) that:

A director or other officer of a corporation [which would also generally include a chief financial or operating officer, for instance] must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

  1. were a director or officer of a corporation in the corporation's circumstances; and
  2. occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

Justice Austin found that:

the word 'responsibilities' was intended to direct attention to the factual arrangements operating within the company and affecting the director in question – as opposed to the legal duty of care, implying specific legal duties in particular circumstances.

As Justice Austin went on to explain, while paragraph (a) might provide a minimum standard of care and diligence, the actual responsibilities of a particular director may result in additional legal duties. Justice Austin held that these responsibilities were not limited to specifically delegated tasks through the articles of a company's constitution (such as relate to chairing a meeting) as submitted by the counsel for Mr Greaves. Rather, Justice Austin agreed with ASIC's contention that it was a wider concept and that it would be determined by the responsibilities with which Mr Greaves was entrusted by reason of his experience and expertise (as the former finance director of Fairfax and chief financial officer of Optus) and his position as chairman of One.Tel and chairman of the Finance and Audit Committee.

The range of responsibilities

It is not clear whether being chairman necessarily extends the legal duties of a director (although this is also one of ASIC's contentions), but Justice Austin supported the approaches of Justice Rogers in AWA v Daniels and Justice Romer in Re City Equitable Fire Insurance Co, and the process of determining responsibilities that rest with chairmen as a matter of contemporary practice rather than law.

Justice Austin notes that in the main proceedings, ASIC will seek to demonstrate that, as a matter of usual practice, chairmen are more responsible than other directors for ensuring that the board of a company knows its financial position. The precise range of these responsibilities no doubt will be the subject of much argument in the substantive proceedings later this year. The range of responsibilities may extend from an obligation to take reasonable steps to ensuring the provision of material financial information to the board (including, as ASIC contends, to taking reasonable steps to ensure the appointment of an appropriately qualified finance director), to taking reasonable steps to ensure compliance with continuous disclosure obligations. Whether those responsibilities extend as far as ASIC contends, that is to taking reasonable steps to ensure the company has sufficient cash reserves to fund its continuing activities, will be highly contentious.

Defences

Counsel for Mr Greaves contended, with limited success, that the extent of responsibilities as pleaded by ASIC was inconsistent with the accepted principles of reliance by directors on others. Justice Austin noted that, while there is some authority for a director reasonably to rely on experts or delegates, this reliance is subject to limits, including the fundamental and continuing obligation to keep informed about the activities and financial status of a company. The extent that this duty can be discharged by reliance may well be crucial in determining the charges against the One.Tel directors.

The statutory business judgment rule also will be raised as a defence. In ASIC v Adler, Justice Santow held that none of the defendants were able to rely on the defence because they either failed to make a judgment or their judgment was tainted by material personal interest. ASIC may well contend again that, in relation to certain decisions of the directors, their decisions were tainted by material personal interest, having regard to their substantial shareholdings in One.Tel. The case is likely to provide further guidance as to the application and availability of this safe harbour.

Conclusion

Justice Austin has held that a reasonable cause of action can be founded on the basis of a chairman having a greater duty of care and due diligence arising from the chairman's responsibilities. Best-practice exhortations to ensure an appropriate mix of skills when determining the composition of a board may, subject to certain minimum standards, also affect individual director's duties. Additionally, the scope of appointments of individual directors, both to the main board and to committees, may also affect duties.

No doubt the final judgment (and any appeal) will cast further light on the relationship of these factors in determining a director's duties. This is only part of the equation. ASIC's One.Tel proceedings are equally likely to provide guidance on defences such as the business judgment rule.

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