Hot on the heels of the Feltex decision vindicating the right of directors to rely on advice,1 the New South Wales Court of Appeal has released a judgment that considers in some detail what happens when there are gaps in advice, or the advice is based on unchallenged assumptions.
The findings underline that director and officer liability will always depend on the particular context. But there are some broader lessons to be drawn.
The case of Morley v Australian Securities and Investments Commission2 was heralded by the Australian Securities and Investment Commission (ASIC) as examining "the fundamental responsibilities of public companies and of both executive officers and non-executive directors".3
We agree, but the Court of Appeal does not set out to draw any bright lines: perhaps the most important lesson from NSW is that responsibility will always be a contextual question. The judgment is a 1,156-paragraph opus that delves deeply into the factual background, making it clear that in Australia, directors' and officers' legal liability will closely reflect their actual share of responsibility in the running of the company.
There are, however, some concrete take-home points:
- governance members can be liable despite relying on accurate advice. The Court of Appeal found that the company's executive officers had a duty to explain to the board the limits of the advice on which it was relying (in this case, analyses which did not extend to challenging certain key inputs and assumptions)
- the appeal turned on a question of fact – whether a draft ASX release was approved by the board or not. Diligent and accurate minute-keeping would have resolved the point much sooner, and
- the Court indicated that directors attending by telephone cannot expect to rely entirely on other directors: if a document arises for resolution, they should either abstain, or obtain a copy and exercise their own judgement.
ASIC also proceeded against the company – James Hardie Industries – on a number of grounds. 4 One notable issue was a breach of continuous disclosure requirements, which may have some resonance in New Zealand given the youth of our continuous disclosure regime.
Background – findings at trial
The cases centre on a 2001 ASX press release by James Hardie Industries. The ASX release outlined a corporate restructure whereby asbestos-related liabilities of the group were transferred to a new entity, the Medical Research and Compensation Foundation (the Foundation). The ASX release conveyed that the Foundation had sufficient funds to satisfy historic asbestos liabilities whereas there was in fact no supportable basis for this statement.
The trial court found that:
- certain directors had approved the release knowing that it conveyed, or was capable of conveying, full funding
- other directors, who had participated in the relevant meeting by telephone, failed to either familiarise themselves with the draft announcement or to abstain from voting for its approval
- the company's General Counsel and CFO were 'officers' of the company, meaning that they had statutory duties to act with reasonable care under the Australian Corporations Act (this result might have been different in New Zealand as the New Zealand Companies Act has no 'officer' category – although 'director' is defined inclusively, and includes "a person occupying the position of director of the company by whatever name called". The legislation can also deem people directors), and
- both the General Counsel and the CFO had failed to advise the board that advice analysing the Foundation's ability to meet liabilities – while correct – was premised on inputs and assumptions that undermined its usefulness in determining whether the Foundation would be able to meet its obligations.
The defendants were ordered to pay pecuniary penalties of A$30,000-A$70,000, and were disqualified from managing a corporation for between five and seven years.
The decision on appeal
The appeal turned on whether or not the directors had in fact approved the ASX release. The Court of Appeal allowed the directors' appeals, but dismissed the General Counsel's and CFO's appeals in respect of advising the board.
ASIC is seeking special leave to appeal to the High Court of Australia.
Liability of non-executive directors an evidential issue
The directors owed their success to the Court's view of the evidence and of the threshold of proof that ASIC is required to meet in regulatory proceedings of this type. The Court found that there was insufficient evidence to say that the board had approved the draft announcement, although if it had been approved the directors would have been in breach.
The Court of Appeal's view of the proper evidentiary and procedural approach to civil proceedings of this type was key to its conclusions. In particular, the Court found that:
- although ASIC does not bear the same duties as a prosecutor, who is required to act far more neutrally than a civil advocate, 5 ASIC's position imports a duty of fairness to defendants, and greater neutrality than is usually required in civil proceedings
- ASIC should have called one of the lawyers at the relevant meeting as a witness to whether or not the directors had in fact approved the ASX release, and
- these types of penalty proceedings are likely to require proof beyond the ordinary civil 'balance of probabilities' standard. Higher standards of proof are common in cases where the allegations are particularly grave (e.g. fraud), but it is useful to see an Australian court recognise civil penalty cases as demanding more than the usual level of certainty. Exactly what the higher standard requires is a more difficult question. Thresholds of proof are notoriously difficult to put into words – the Court discussed a number of prior cases, each of which tended to express the additional element in a different way. In summarising, the Court used the language of "comfortable satisfaction" and/or "reasonable satisfaction" as to the accuracy of ASIC's allegations.
This guidance from New South Wales should be welcomed, as civil penalties form a growing part of New Zealand's commercial law, with pecuniary penalty offences in the Commerce Act, Securities Act and Securities Markets Act (although the Companies Act currently primarily relies on private enforcement, and other commercial statutes are still based around summary offences).
Civil penalties remain a slightly awkward area of the law, with judges not always sure exactly where these cases fall between a criminal law standard and ordinary civil principles.
Regulators should review their approach in light of the Court of Appeal's comments. At present, the Commerce Commission adopts a Model Litigant Policy6 mandating "an even-handed approach in the handling of litigation" and eschewing tactical actions, but this Policy adds little if anything to the ethical rules applicable to all trial lawyers.
Lessons for New Zealand directors
In the wake of the Feltex decision, New Zealand Shareholders Association Chairman John Hawkins questioned the value of directors if they have no legal liability in cases where advice is taken, saying:
One answer is that the board is responsible for spotting any gaps between the various pieces of advice it receives. In the Morley case, responsibility (and liability) fell on the General Counsel and CFO for failing to point out to the board that the advice upon which the Foundation's capitalisation was calculated was based on untested inputs and assumptions.
Under New Zealand law, responsibility for identifying relevant issues falls primarily on directors. Our Companies Act does not recognise the 'officer' category under which the General Counsel and CFO were found liable (although the definition of director includes 'de facto' or 'shadow' directors). Section 138 of the Companies Act makes clear that a director may rely on advice only if acting in good faith with no reason to assume that reliance is unwarranted, and – importantly – only if proper inquiry has been made where the need for inquiry is indicated by the circumstances. Where advice is based on a long list of assumptions, inquiry may well be warranted into the reasonableness of those assumptions.
The case against the company: relevance for upcoming New Zealand continuous disclosure cases?
The Court of Appeal's judgment in the case against the company upheld the trial judge's finding that the delay in disclosing details of the restructure breached the Corporations Act, underlining that the test for whether information requires disclosure is objective: it ultimately comes down to whether a judge thinks that the information was sufficiently material at the relevant time, not the issuer's view:
New Zealand law is broadly the same. These types of claims would be dealt with by the Securities Commission under the 2008 additions to the Securities Markets Act 1988, which give statutory force to the continuous disclosure provisions of any applicable listing rules.
These new provisions have created an emerging area of litigation in which the initial results are difficult to predict. Although the test for materiality is objective, there may still be plenty of room for argument where the information in question is contingent or predictive. 7 What's more, the volatile conditions that might allow directors to take a view that forecast information is not material are exactly the conditions in which investor action is more likely.
Three cases currently before the courts are:
- Nuplex - the Securities Commission alleges that from 22 December 2008 until 19 February 2009 Nuplex Industries Limited breached its continuous disclosure obligations under the NZX Listing Rules and the Securities Markets Act 1988 by failing to disclose to the market a breach of a banking covenant8
- Nufarm - New Zealand investors have joined an Australian class action against Nufarm Limited, an Australian based company, alleging breach of continuous disclosure obligations, and misleading and deceptive conduct. In mid-2010 Nufarm halved its profit forecast from March. Shares dropped by more than 30%. The class action claims that Nufarm lacked reasonable grounds for its March forecast, and delayed announcing the decreased forecast in breach of its obligations, and
- Insured Group (formerly Lombard Group) - the Securities Commission this week began civil proceedings against Insured in relation to Lombard Group's alleged non-disclosure in 2007 and 2008 of material financial information, such as loan book quality and liquidity. This should be a warning to companies to do due diligence before back door listings, as Insured Group did not buy Lombard Group until 2010 – two years after the alleged breaches occurred. The Commission did not directly advise Insured that it was investigating Lombard but did inform the market more generally that it was investigating all failed finance companies.
3. ASIC Media Release 10-273MR, 17 December 2010
5. In New Zealand the duties of the prosecutor are informed by the Prosecution Guidelines 2010 published by Crown Law Office. The Prosecution Guidelines emphasise the prosecutor's role as an officer of the court. A prosecutor is less entitled than a civil advocate to act in an adversarial manner, because the role of a prosecutor is to protect the public interest, which includes promoting fairness to an accused: "[t]he obtaining of a conviction is a consequence, not the object of a prosecution". Available at www.crownlaw.govt.nz
6. Available at www.comcom.govt.nz
7. For example NZSX/NZDX Listing Rule 10.1.1 requires immediate disclosure of any Material Information, but not in circumstances when a reasonable person would not consider disclosure necessary (yet), or the information remains a matter of supposition, or is insufficiently definite to warrant disclosure
8. See also our Brief Counsel on the Nuplex case
The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.