On 17 December 2010, the Supreme Court of New South Wales Court of Appeal handed down the decision Morley & Ors v Australian Securities and Investments Commission  NSWCA 331, an appeal brought by former officers of James Hardie Industries Limited (JHIL).
The Court of Appeal overturned the NSW Supreme Court ruling that found the non-executive directors of JHIL had mislead the Australian Stock Exchange (ASX). However, on 14 January 2011, the Australian Securities and Investment Commission (ASIC) sought special leave to appeal the Court of Appeal's decision to the High Court.
Background to the proceedings
In February 2001, JHIL's board published a proposal to establish a foundation separate and distinct from the James Hardie Group (JHG) to exclusively handle any of JHG's past or future asbestos liability. ASIC made various allegations against JHIL, its officers and James Hardie Industries NV (JHINV) concerning statements made pursuant to a board meeting in February 2001 as to the financial capacity of the foundation to deal with all asbestos related claims going forward.
The courts considered the following issues as to whether:
- an ASX announcement as to the ability of a foundation
established by JHIL to cover all past and future asbestos-related
claims contained misleading or false statements in contravention of
the Corporations Act (the Act) and whether
officers of JHIL had breached provisions under the Act through the
preparation and ultimate approval of those false statements.
The Supreme Court held that:
- JHIL's Australian non-executive directors either knew or ought reasonably to have known that the foundation was not sufficiently capitalised to meet all past and future asbestos related claims and that the draft announcement was misleading in that respect
- JHIL's American non-executive directors, who attended the February 2001 board meeting by telephone-link, that as directors of the company, failed to request that they be provided with a copy of the announcement or familiarise themselves with the terms of the announcement prior to voting, or abstain from voting in favour of the resolution and authorise its execution
- JHIL's General Counsel and Joint Company Secretary, must or at least ought to have been aware that if JHIL authorised the release of a public statement concerning separation that was false and misleading, it would be harmful, or potentially harmful, to JHIL.
- JHIL had failed to disclose information relating to a Deed of Covenant and Indemnity (DOCI) executed in early 2001. The Supreme Court held that JHIL's GC and JCS failed to discharge his duties to JHIL by failing to advise, or seek advice for, JHIL's Chief Executive Officer (CEO) or the board of JHIL as to whether JHIL was required to disclose the DOCI information to the ASX.
- a memorandum of advice sent to shareholders to approve the restructure was misleading – namely that it stated that partly paid shares enabled JHIL to call on JHIVL for funds to meet liabilities, knowing that the partly paid shares were to be cancelled after the restructure.
The Supreme Court held that:
- JHIL's GC and JCS must have realised that there were not sufficient funds in the foundation to cover all legitimate past and future asbestos claims
- the contravention alleged against JHIL's Chief Financial Officer (CFO) were not linked to the draft ASX announcement but rather to the alleged failure to advise the board of the limited nature of the reviews of the cash flow model by PriceWaterhouseCoopers (PWC) and Access Economics.
Implications for non-executive directors
Important points for non-executive directors
- The Court of Appeal decision serves as a reminder to non-executive directors that, although they may not be involved in the day-to-day running of the business, they are officers of the company and, as such, will be liable for any failure to meet the standard of care and diligence expected of a person in their position.
- Central to the Court's finding was that the 'ordinary, reasonable non-executive director' is to be imbued with the knowledge, skill and expertise of the particular director when considering whether due care and diligence was exercised.
- Given the usual leniency afforded to non-executive directors in relying upon the board to 'craft' adequate resolutions, the reasonableness of this reliance is to be determined as a matter of fact. It is therefore important that prior to voting, each director familiarise themselves with the details and factual background of the resolution to be passed.
In relation to JHIL's non-executive directors and combined GC and JCS, the Court of Appeal first considered whether the board ever turned its attention to the announcement at the February 2001 meeting and if so, whether the announcement was misleading or deceptive, or likely to mislead or deceive in contravention of the Corporations Act.
A matter of evidence: did the directors approve the announcement?
On appeal, the principal stumbling block for ASIC was its inability to demonstrate that the announcement concerning the ability of the foundation to cover all past and future asbestos claims was considered by the board in the February 2001 meeting.
The appellants argued that ASIC had a higher duty than a normal litigant when prosecuting directors due to the severe harm to earning capacity that could follow being disqualified as a director.
The court approved the appellants' submission that an adverse inference ought to be drawn from ASIC's failure to call relevant witnesses, which undermined the cogency of its case.
A hypothetical scenario
The court considered whether or not there would have been a contravention of the Corporations Act in a hypothetical situation where the directors assented to the announcement.
The Court of Appeal affirmed that:
- the relevant test involves an objective inquiry that takes into consideration the knowledge, experience and particular skills or expertise of the particular director
- a non-executive director may rely upon management and other officers to a greater extent than an executive director
- each case will turn upon its facts.
The court held that '[t]hese were not circumstances in which a non-executive director, exercising due care and diligence, could accept without application of his or her mind to the draft news release before the board for its approval'.
The appeals of Messrs Michael Gillfillan and Martin Koffel (directors of JHIL) were considered separately and turned upon whether, despite participating via video link, they should have:
- requested that they be provided with a copy of the Draft ASX announcement; or
- otherwise familiarised themselves with the terms of the announcement; failing which they ought to have abstained from voting on the resolution which sought to pass the announcement.
While the appeal ultimately turned upon the failure of ASIC to discharge the burden of proving that the board approved the resolution, the court nevertheless considered that in the hypothetical situation whereby the board approved the announcement, '[a] reasonable director with their expertise would understand the need to familiarise themselves with what was being proposed, even when his or her participation was over the telephone.'
Implications for general counsel
Important points for general counsel
- General Counsel who participate in company decision making also act as officers of the company and are subject to the standards of care and diligence set out in section 180(1) of the Corporations Act. What is required of General Counsel in order to discharge their duty to the company depends on the circumstances. The fact that JHIL's GC was also its JCS was determinative of his role as an 'officer' of the company. However, a word of caution: it would be a stretch to argue that the court's determination would have differed had JHIL's joint GC and JCS been occupied solely as GC. It is important to keep in mind that the test is not to be determined in the abstract by reference to title or position but rather, whether the person has an active role in making decisions that affect the company.
- The Court of Appeal was careful to emphasise that there is no assumed threshold of knowledge when advising board members as to the potential implications of decisions. This may be viewed as imposing a greater burden upon corporate lawyers and non-executive officers to flag potential liabilities, even if they are obvious.
- The court clarified the point that retaining external solicitors will not be sufficient to discharge the duty owed under the section 180 of the Corporations Act. If in doubt, it is better to err on the side of caution when advising or seeking advice.
- There are multiple ways in which counsel may discharge its obligation to act with diligence. The Court of Appeal outlined that it would have been sufficient for JHIL's CS to advise or seek external advice for either the CEO or the board. Importantly, the court qualified that seeking external advice may not be sufficient to discharge the obligation of general counsel, though each case is to be determined on its own merits.
The Court of Appeal considered whether JHIL's GC and JCS had failed to discharge his duty owed to the company by failing to advise or seek advice for JHIL's board or CEO as to whether JHIL was required to disclose information relating to a DOCI executed in early 2001.
The appeal of Mr Peter Shafron, JHIL's former GC and JCS, was allowed in part. A preliminary matter for the court's consideration was whether the GC was an 'officer' within the meaning of section 9 of the Corporations Act. The trial judge held that the GC was an officer given his participation in decisions affecting the whole or a substantial part of JHIL's business. Though criticising the trial judge's reliance upon Commissioner for Corporate Affairs v Bracht in determining the meaning of 'take part in', the Court of Appeal ultimately agreed with the trial judge's conclusion. Their Honours concluded that Mr Shafron was the second or third most senior executive of JHIL and, though he did not have ultimate control over decision making, 'what Mr Shafron did went well beyond administrative arrangement, and well beyond providing advice or information as required, and is correctly described as participation in decisions affecting the whole or a substantial part of JHIL's business.' The court was careful to qualify the significance of this finding, concluding that satisfaction of the definition in the Act only gives statutory status and does not of itself constitute a contravention.
Grounds of appeal
The Court of Appeal upheld two of the three contraventions found by the trial judge.
- The draft ASX announcement: the court rejected Mr Shafron's submission that the proper discharge of his duties did not require him to tell the directors 'what they already knew' – that the announcement was false and misleading – contending that JHIL's GC and JCS could not rely upon the knowledge or ignorance of the board members in order to discharge his duty to exercise reasonable skill and care which, in the Court's opinion, required bringing the potential implications of a misleading statement to the board's attention.
- The cash flow analysis: Mr Shafron accepted that he did not say anything to the board to the effect that the cash flow analysis submitted by PWC and Access Economics was limited to logical soundness and technical correctness. The Court of Appeal, overturning the finding of the trial judge, concluded that ASIC failed to discharge the evidentiary onus that JHIL's GC and JCS was aware of these limitations.
- Deed of Covenant and Indemnity (DOCI)
disclosure: in upholding the decision of the trial judge
the Court of Appeal found that Mr Shafron may have discharged his
obligations in one of three ways:
- Advising JHIL's CEO or the board that they needed to consider whether disclosure was required
- Obtaining advice from a qualified third party as to whether disclosure was required
- Advising JHIL's CEO or the board to consider whether disclosure was necessary.
The court made several findings in relation to discharging this duty.
Firstly, obviousness will not be an answer to an alleged contravention. General counsel will be required to raise the issue of disclosure for the board's consideration even though the matter may speak for itself.
Secondly, it would have been sufficient for the Mr Shafron to advise or seek external advice for either the CEO or the board. In the circumstances he failed to do either.
Finally, even if Mr Shafron had retained external solicitors, who may reasonably be expected to advise on disclosure, there was a real question as to whether the firm in question had been retained. The court found it had not and it was not sufficient to discharge the obligation of general counsel.
Implications for chief financial officers (CFO)
Important point for chief financial officer's
Similar to its findings against JHIL's GC and JCS, the Court of Appeal emphasised that there is no threshold of assumed knowledge. The lesson here is that where there is potential for the board to gain the wrong impression, full and frank disclosure as well as repeated emphasis of important points between a board and CFO will insure against liability for failure to advise.
The Supreme Court determined that Phillip Morley, JHIL's CFO, failed to discharge his obligation of due care and diligence owed to JHIL by circulating a misleading memorandum of advice to shareholders. The memorandum stated that partly paid shares enabled JHIL to call on JHIVL for funds to meet liabilities, despite Morley knowing that the partly paid shares were to be cancelled after the restructure. The two issues considered on appeal were:
- whether a CFO is an 'officer' under the Act
- whether the trial judge erred in finding that Mr Morley failed to discharge his duty to act reasonably by failing to advise that the cash flow analysis review by PWC and Access Economics was limited to logical soundness and technical correctness.
Mr Morley as an 'officer'
The court accepted, as a matter of fact, that Mr Morley participated in major decisions affecting the worth of the company. Counsel for Mr Morley submitted that in presenting the cash flow analysis, the CFO's function was purely administrative, involving the mere presentation of a model which he had not been involved in drafting.
Despite finding that Mr Morley was a 'significant driver in the proposal', the court acknowledged that it is not appropriate to divide up an employee's functions but rather, to determine whether the person, considering their roles holistically, has the statutory status of an officer which requires an active participation in making decisions affecting the company.
The court accepted that Mr Morley had the capacity to affect JHIL's financial standing. The court determined this capacity as a matter of fact and degree in each situation, rather than by reference to 'the capacity of an abstract chief financial officer.'
The contravention alleged against Morley was not linked to the draft ASX announcement. The court was not of the view that the CFO should have protested about the material contained in the announcement which was likely to mislead or deceive. Rather, the CFO was found liable for having failed to advise the board of the limited nature of the reviews of the cash flow model for the foundation which had been executed by PWC and Access Economics. Mr Morley made a presentation to the board that the reviews were 'logically sound and technically correct' in their assessment that the foundation was sufficiently capitalised to meet all past and future asbestos claims.
The CFO submitted that the expression 'logically sound and technically correct' in conjunction with his presentation at the February meeting was to make it clear that the review by PWC and Access Economics had not extended to a review of the assumptions underlying the model. The Court rejected this submission concluding that '[i]n our opinion the presentation by Mr Morley...gave the impression, or was capable of giving the impression, that an unlimited review had been conducted. In this context he ought to have advised the board of the limited nature of the review.'
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