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The ongoing challenges of being a company director

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2009 has proved to be an interesting year for company directors. Their role, obligations and duties have been highlighted with several high profile cases. The recent (and continuing) James Hardie litigation, the Victorian Court of Appeal in ASIC v Lindberg ( the Australian Wheat Board case) and the looming civil court legal action against the directors of Centro point to turbulent times for company directors.

As the ramifications for poor performance are serious and directors stand liable for not complying with their obligations, MST will provide regular updates for company directors via our newsletter. We will address issues such as what makes a good board and why have a board, the role of the Chairman, the extent and limits of director / officer insurance and indemnity, and improving the functionality of boards, the impact of Court rulings on director duties, and the challenges facing directors in complying with their fiduciary duties. We will also provide updates on how the Courts are ruling in ongoing high profile key cases and explain their implications for directors.

In its Annual Report released on 5 November 2009, ASIC stated that they had undertaken 35 civil proceedings to recover assets, costs and fines totalling more than $28.3m. The Regulator reported that in 2009, it completed a record 39 criminal proceedings with 34 convictions (including 19 jail terms). Whilst many of the ASIC convictions related to the financial services industry, a significant number were specifically associated with board members who failed to comply with their legal obligations as directors. The Regulator also reported that between June and September 2009, 15 directors were disqualified from managing corporations for a combined total of over 50 years.

The message is clear for company directors: accountability for performance is an important and ongoing issue and should never be disregarded. Operating in an environment of ever increasing media scrutiny, shareholder activism, higher community expectations and regulator vigilance, we anticipate that the issue of board competency and director duties will remain in the spotlight in 2010.

Policy and Statutory Framework

Whilst a corporate entity may vary in form from being a public (ASX) listed company to a tightly held proprietary company, the role and obligations of the entity’s directors remain the same. S198A of the Corporations Act allows for a company to be managed by its board of Directors. They are responsible for the direction and performance of the company. Whilst the company’s management are responsible for day-to-day operations, directors are ultimately responsible for the entity and they act on behalf of the company shareholders. The board may be the company’s decision maker and may act collectively, however each director will be held individually accountable and will be subject to scrutiny.

James Hardie fallout: implications for Directors

In August 2009, Justice Gzell of the New South Wales Supreme Court disqualified from managing a corporation (for periods between 5-15 years), three former executives and seven former non-executive directors of the James Hardie Group. On the basis that each of the directors had breached their statutory duty of care and diligence, the directors were also heavily fined (with amounts ranging from $30,000 to $350,000). The case, ASIC v Macdonald (No 12) [2009] NSWSC 714, was significant, not merely because it was so high profile, but because the Court was very firm about what it viewed as the standard of care expected of directors.

The key facts of the case centred on the duty of management and the board to exercise their statutory duty of care and diligence. In issue was a media release to the ASX. The Court held that the communication failed to include information considered being material and highly significant to the overall strategy of the company. Specifically, the disclosure statements released by the board in relation to the status of the adequacy of asbestos compensation funding were found by the Court to be false or misleading. The directors were held to have breached the statutory duty of care and diligence in section 180(1) of the Corporations Act.

The Court also considered in some detail, the requirements of directors in monitoring the actions of management. It was found that the management had failed to adequately advise the board of the company’s continuous disclosure obligations. More significantly, the Hardie board had delegated its responsibility to management for the ASX media announcement which contained material that was false and materially misleading, and that this was, in the Court’s eyes, unacceptable.

The Hardie case sends directors a clear message: they must be vigilant in terms of their monitoring of management and they must be aware of the risks associated in discharging their statutory duties. It is clear from the Court’s decision that it is no longer acceptable for a board to rely upon or delegate its key responsibilities to management.

The Hardie directors relied upon two key statutory defences with little success. Section180 (2) of the Corporations Act, commonly referred to as the business judgment rule, and s189 (reliance on others) provided little relief. Sections 1317S and 1318 may, in certain situations, also provide some protection for directors where they have breached their duty. The provisions recognise that directors are required to make decisions that entail a degree of commercial risk. Sometimes information used in the Board decision making process may be incomplete. The Court will have wide discretion where it appears that the director has acted honestly when breaching their statutory duty, and therefore under these protection provisions, a director ought fairly to be excused. The basic question will be whether or not a director has acted honestly, fairly and in good faith.

James Hardie and a number of its directors have lodged an appeal against the declarations and orders made against it by the Court.

Centro: landmark litigation about to commence

ASIC is pursuing eight former and current directors and executives of the Centro Properties Group and Centro Retail Group for allegedly falsely stating $2.1 billion of liabilities in the 2007 financial accounts. If found guilty of breaching their duty of care, the directors and executives may face disqualification from managing a corporation and substantial fines. In issue is whether or not the directors and executives knew that Centro could not refinance $1.3 billion of debt. As in the Hardie case, director and board  responsibility to act with due care and diligence in decision-making, continuous disclosure obligations and the question of the issuance of material statements to the market will be considered.

The Centro case is also notable in that it is the first case before the Court that deals with a written declaration by a listed entity’s chief executive and chief financial officer to directors over the financial accounts’ compliance with accounting standards. ASIC claims that the 2007 balance sheets of Centro Properties Ltd and Centro Property Trust did not correctly classify interest-bearing liabilities as current and that the directors should have known that these liabilities were incorrectly classified in the financial reports. The consequences for Centro were dire. The share price plunged, the Properties Group reported a $3.54 billion annual net loss after property revaluations and the Retail Group reported a $2.68 billion annual net loss for the same period.

Steps Directors can take to protect themselves

With the James Hardie and Centro cases top of mind, the Federal Government has recently commissioned its advisory body, the Corporations and Markets Advisory Committee (CAMAC) to examine what guidance is required for directors to fully understand the responsibilities of their role. CAMAC will provide a report on whether or not the performance of directors would be enhanced by the introduction of a code of conduct or best practice guidance.  The report is due by April 2010.

In the meantime, directors may find the ASX Corporate Governance Principles and Recommendations (2007) of value. Whilst the Principles are specifically directed at public listed companies and are not mandatory, the responsibilities specified are appropriate to all boards and their directors irrespective of the entity’s corporate structure.  They include:

  • Overseeing the company  including control and accountability systems;
  • Appointing and removing the chief executive officer;
  • Where appropriate, ratifying the appointment and removal of senior executives;
  • Providing input into and final approval of management development of corporate strategy and performance objectives;
  • Reviewing, ratifying, and monitoring a system of risk management and internal control codes of conduct and legal compliance;
  • Monitoring senior executives performance and implementation of strategy;
  • Ensuring appropriate resources are available for senior executives;
  • Approving and monitoring the progress of major capital expenditure, capital management and acquisition and divestitures and
  • Approving and monitoring financial and other reporting.

Over and above fully understanding what is required in the role, directors should, as a matter of good practice:

  • Make sure they have read and appreciated the content of the board papers. It is particularly important that directors pay special attention to all financial material being presented. Preparing questions and considering any issues that should be raised and reviewed at the next committee or board meeting are also part of the role. Any information provided at a committee meeting that has relevance for the full board should be passed on by a director to their board colleagues.
  • At every meeting, directors should ensure that they listen carefully to the messages from the company’s executives. Key is accuracy of information being presented to the board by senior executives. Many executives will be proficient in telling a board what they want to hear. For directors, it is worth taking the time to also consider what may not have been communicated by executives to the board.
  • It is incumbent upon a company’s directors to provide an open forum for discussion of issues. It should not always be about good news- directors should want and moreover, need to know the bad news. Directors have a powerful role to play in resolving a company’s problems. The executives should be able to benefit from a director’s business acumen and past experience.
  • Directors should carefully check all board minutes and ensure they reflect what actually transpired at the meeting. If they don’t, a director should table objections or amendments and check that these amendments are minuted and board minutes are updated.
  • The company should have comprehensive and well documented procedures and policies in addition to a solid Corporate Governance framework. It is incumbent upon a director to ensure the organisation follows and lives by these policies.
  • The role of a director includes providing business knowledge in order to improve the capabilities and bottom line of the business. This does not mean that the board meeting is merely a once a month social catch up for the director with their board colleagues. Cases such as James Hardie clearly show that boards must be very attentive to actions taken by the company executives as it is the directors who will ultimately be held to account.
  • The Corporations Act is very strict- directors have a duty to prevent insolvent trading by a company. With this in mind, a director must ensure that they have a thorough understanding of financial and accounting standards and their implications for the business.

In summary, directors are in a fiduciary relationship with their company and therefore owe a duty of good faith and loyalty as well as duties of care, skill and diligence. A failure to comply with these duties may result in a director being sued and if found guilty, they may face heavy fines and penalties. As the ramifications for poor performance are serious and directors stand liable for not complying with their obligations, MST will provide regular updates for company directors via our newsletter.

Should you have any further enquiries, please contct on of our Corporate Advisory lawyers.

Author: Susan Reece Jones