Tag Archives: Director’s Liability

High Court decision gives broad reading of officeholders’ statutory duty of care and diligence

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The High Court delivered judgment today in ASIC’s regarding the directors of James Hardie Industries Ltd (JHIL) (link).  The Court also delivered judgment in a related appeal by the “General Counsel and Company Secretary” of JHIL at the time,  Peter Shafron, against ASIC (link).

These appeals involve the infamous separation by JHIL of certain asbestos making subsidiaries that had significant exposure to asbestos related diseases.  Readers may recall that JHIL represented at the time of the separation occurring that the subsidiaries had sufficient funding to cover future claims against them.  It turned out they did not, by a long shot.

ASIC pursued the directors and officers of JHIL for breaches of various statutory duties arising out of the transaction.  He was subject to various penalties as a result.

The decision regarding Peter Shafron is interesting because it illustrates the breadth of the statutory duties imposed on an “officer” as defined in section 9 of the Corporations Act (link).  The Court has made clear that it is the actual responsibilities of the office holder and their skill set in that field that define the area within which duties of care and diligence apply.

In brief terms, Shafron was found at trial and affirmed on appeal to have breached his duties under s180(1) (link) to JHIL as its “joint General Counsel and Company Secretary”.  Two breaches were the subject of the appeal.    The first breach was that he failed to give the board of JHIL advice that certain information in a deed involved in implementing the separation should have been disclosed to the ASX.  Second, he failed to advise the board that cash flow modelling used to estimate JHIL’s exposure did not take into account superimposed inflation of the cost of meeting medical claims (being medical costs inflation over and above the general level of price inflation), and accordingly was not an adequate guide to the required level of provisions.

Shafron argued that his alleged contraventions could not give rise to a breach of s180(1) because they arose from work he did in his capacity as General Counsel, and not in his capacity as a statutory officer.  He argued that he could only be liable for a breach of his statutory responsibilities as company secretary, which he argued were generally administrative and did not involve providing legal advice.  He argued that whatever duties he had as in the role of General Counsel were not within the statutory responsibilities of a company secretary.

The High Court disposed of this argument swiftly by means of the construction of s180(1).  The Court held that on any reading of s180(1)(b), the duties of care and diligence on the office holder are in respect not only of the statutory responsibilities of the office, but also in respect of whatever responsibilities that particular office holder has been given or has assumed within the corporation.   The High Court’s analysis is at paragraphs [18] to [20] of the judgment.  In particular at para [19] the Court held:

…..The effect of par (b) of s 180(1) is to require analysis of what a “reasonable person” in the same position as the officer in question would do. His or her position is not adequately described unless regard is had both to the office held and to the responsibilities that the person has. Further, Mr Shafron’s submissions ignored the evident difficulty in defining, for the purposes of limiting the conduct considered, the content of “the office held” where a person is an officer by virtue of par (b)(i), (ii) or (iii) of the definition of “officer” in s 9. A construction which avoids that difficulty, and avoids a more limited operation of s 180(1) in relation to some officers than in relation to others, is to be preferred.

In this case, Mr Shafron’s responsibilities were found by both the primary judge and the Court of Appeal to have included the tendering of relevant advice (including legal advice) about disclosure requirements. As the Court of Appeal rightly said:

“A company secretary with legal background would be expected to raise issues such as potential misleading statements (in relation to the draft ASX announcement) and disclosure obligations (in relation to the DOCI) with the board. Ordinarily it might not be the same with respect to a matter such as the JHIL cash flow modelling, which required particular expertise. But Mr Shafron had a quite close involvement with the cash flow modelling, and raising the limitations of the cash flow model [based on the material Mr Shafron had obtained from Trowbridge] is by no means a legal matter for the attention of general counsel; the involvement, and raising the limitations, in our view fell within Mr Shafron’s responsibilities as company secretary.” (emphasis added)

That is, Mr Shafron’s “responsibilities within the corporation” extended to the several subjects identified. Once it was found that his responsibilities extended to those subjects, the question became whether Mr Shafron undertook those responsibilities with the requisite degree of care and diligence.

Regards

Mark

Proposed Law on Phoenix Activity Falls Flat

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Proposed legislation to attack directors of companies involved in so called “Phoenix” activity appears to have fallen flat owing to two major bungles in the drafting of the amendments in one of the bills.

The Federal Government has released drafts of two Bills.  The Bills follow pre-election commitments in the Protecting Workers’ Entitlements package announced in July 2010.

Identifying Phoenix Activity

Distinguishing “Phoenix activity” from the legitimate cycle of business failure is sometimes complicated and involves issues of intention.  In the 2009 paper entitled “Phoenix Proposal Paper” (link), the Treasury noted the following:

Defining precisely what constitutes fraudulent phoenix activity is inherently difficult….underlying the distinction between illegitimate, or fraudulent, phoenix activity and a legitimate use of the corporate form, is the intention for which the activity is undertaken. Relevantly, ASIC draws a distinction between businesses that get into a position of doubtful solvency or actual insolvency as a result of poor business practices (for instance, poor record keeping or poor cash management practices) and those operators who deliberately structure their operations in order to engage in phoenix activity to avoid meeting obligations. (emphasis added).

The government’s proposed legislation really does not deal with the difficulty of identifying what is and what isn’t Phoenix activity at all.

Penalising the Directors

The Corporations Amendment (Similar Names) Bill 2012 will expose directors to personal liability for their company’s debts, if:

  • the company’s name is the same as or similar to a company or business name of another company that has been wound up; and
  • the director was also a director of that other company; and
  • the company incurs the debts within five years after the start of the winding up of the other company.

This bill suffers from two major problems.  The first and most obvious problem is that personal liability only applies if the subsequent company has the same or a similar name as the old company.  So a director can escape personal liability simply by choosing a new name that is not similar to the old company or business name.

In my view, the director ought be made liable if the new company is carrying on substantially part or all of the same business as the old company, and the Courts should be given some flexibility in applying that test.  The name alone is a poor indicator.  A list of indicators to be taken into account by the Court could be devised in a similar way as exists in applying other evaluative tests, such as section 425(8).  They might include the assets employed, the customer base, the nature of the business conducted, the name of the business, the premises used and the staff employed among other things.  A defence should be available if the director can show that the old company was given fair value for the business.   Further, the Court should have a discretion to excuse directors who have acted honestly and who in the circumstances ought be excused (as exists in the draft bill) to deal with the issue of intention identified in the 2009 paper I noted above.

The second problem is that the director is liable for the debts of the new company, not the old.  The drafters appear to have copied similar legislation in the UK and in New Zealand.  The idea is to hinder phoenix operators from transferring the name of the business and therefore its goodwill, by restricting the limited liability of the new company.

But in most phoenix cases, the creditors of the new company are not at risk since they are usually trade creditors whom the directors need to keep happy.  It is the old company’s creditors like the ATO and other non essential suppliers who need help.

There are a plethora of articles available on the exposure drafts, including very useful posts by AAR (link), Minters (link) and Carrie Rome-Sievers of the Victorian Bar (link) which goes into some detail about the politics of the bills.

The two problems I have identified have both been drawn to the Federal government’s attention in submissions by various bodies and we can only hope that Canberra will fix them.

Providing Access to the GEERS Scheme

The second bill is the Corporations Amendment (Phoenixing and Other Measures) Bill 2012.  It provides ASIC with administrative power to order that a company be wound up, generally in circumstances where ASIC considers that the company has been ‘abandoned’. This will trigger employees’ entitlements under the Government’s General Employee Entitlements and Redundancy Scheme (GEERS).

The second bill is a welcome development as in the past, employees or other creditors left abandoned in the old company shell had to go to the expense of winding up the shell at their own expense.

Regards

Mark