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The full bench of the High Court of Australia yesterday overturned the NSW Court of Appeal Decisions in Morley v Australian Securities and Investments Commission (No 2) and Shafron v Australian Securities and Investments Commission (No2) holding that seven non-executive directors and the company secretary/general counsel of James Hardie Industries Ltd (JHIL) breached their duties as directors or officers of the company in relation to the release of a misleading announcement to the Australian Stock Exchange (ASX).

The two decisions provide a better understanding of ASIC’s duties in bringing proceedings pursuant to the Corporations Act 2001 (Cth) (the Act). They are also, importantly, relevant to defining the duties held by non-executive directors, executive directors and management below board level, as well as clarifying the definition of “officer” under the Act.

Background

In 2007, ASIC brought civil penalty proceedings against seven former non-executive directors, three former executive directors and the company secretary/general counsel of JHIL for breaches of s 180(1) of the Act. It was alleged that each failed to exercise due care and diligence in relation to the release of information to the share market and, by doing so, breached their duties to the company.

The NSW Supreme Court held that seven of the directors breached the Act by approving an announcement to the ASX misleadingly conveying that a trust created to fund asbestos-related disease claims would have sufficient funds to meet all present and future claims. It was later found that the fund was underfunded by $1.5 billion. Mr Shafron, as company secretary and general counsel of JHIL, was also held to have breached the Act by failing to advise the board that the announcement was “expressed in too emphatic terms” or that there were certain potential shortcomings with the economic advice and modelling received by the board from its advisors.

In August 2009, the Court imposed fines and disqualification orders against the directors/officers for breaches of s.180(1) of the Act. Our July 2010 Insurance and Financial Services Bulletin reported on the Supreme Court decision and its implications for directors’ and officers’ liability insurance.

Some of the directors appealed to the NSW Court of Appeal, submitting that the primary judge should not have held that the draft ASX announcement which ASIC alleged had been tabled and approved at the February board meeting had in fact been tabled or approved. The NSW Court of Appeal was satisfied that ASIC had not satisfied this burden of proof given that:

  • the February board minutes which recorded the resolution regarding the ASX announcement contained a number of inaccuracies as to other matters which called into question their accuracy in general and specifically in respect of the ASX announcement; and
  • witnesses called by ASIC were unable to accurately recall events as to the tabling of the resolution.

The Court of Appeal also held that ASIC owed a “duty of fairness” analogous to that owed by a Crown Prosecutor, which it had breached by not calling JHIL’s lawyer, Mr Robb, who had attended the meeting and prepared the board minutes. Failure to call Mr Robb was held to diminish the cogency of ASIC’s evidence in general. ASIC appealed to the High Court against the Court of Appeal decision.

The NSW Court of Appeal held that Mr Shafron had acted in his capacity as an officer, either as a company secretary under s.9(a) of the Act or as an individual who, at relevant times, participated in making decisions that affected the whole, or a substantial part, of the business of JHIL under s.9(b)(i) of the Act, and had breached his duties as an officer. Specifically, the Court of Appeal found that Mr Shafron had contravened s 180(1) by failing to give certain advice to the CEO and to the board and by that failure did not exercise his powers and discharge his duties with the degree of care and diligence that a reasonable person would exercise in the same position. Mr Shafron appealed to the High Court arguing that the omissions alleged by ASIC were omissions in his performance of his role as general counsel and not as company secretary of JHIL, with the effect that the Act did not apply to him since, as general counsel, he was not an “officer” (even though as company secretary he was an “officer”).

The High Court decisions

ASIC’s appeal (ASIC v Hellicar)

The High Court overturned the judgment of the NSW Court of Appeal that ASIC had failed to satisfy the burden of proof that the draft ASX announcement had been tabled and approved at the February board meeting. The High Court found that the board minutes were a formal record of what happened at the meeting and were evidence of the truth of the matters recorded – in particular, that a draft ASX announcement was tabled and approved.

The respondents’ submission that the minutes were inherently unreliable because they were prepared before the February board meeting and contained some inaccuracies, was rejected by the High Court. The High Court held that it would be “too great a coincidence” for not one of the individuals present at the April meeting which adopted the February meeting’s minutes to notice that those minutes contained a resolution which to their knowledge had not been passed. In the High Court’s words, on the respondents’ own case this would have been “a glaring blunder, or worse than a blunder – recording a vitally important resolution which never took place”.

Further, there was evidence that the draft ASX announcement had been circulated at the meeting inasmuch as it was discovered by Mr Robb and from the files of BIL Australia Pty Ltd, a large shareholder in JIHL with which two of the non-executive directors who were present at the meeting were closely associated.

The High Court took a similar view of the ASX announcement itself, noting that while there were some differences between the draft held to have been tabled at the board meeting, the amendments to the draft announcement “are properly described as textual rather than substantive” were not substantial, and the misrepresentations made were the same. The High Court stated that “whether a deed that is later executed or an announcement that is later published is the document which the board approved must be determined by more than a literal comparison between the texts. Slips and errors can be corrected. In at least some cases better (but different) wording can be adopted.” The mere fact that small changes were made would at worst “show no more than that those who made them had no authority to do so” and did not, in this case, show that the draft ASX announcement had not been approved.

The High Court also noted that when the ASX announcement was later circulated, none of the individuals in question demurred or protested as to its terms. This was held to be consistent with the finding that the draft ASX announcement had been approved.

With regard to the ‘novel’ finding of the NSW Court of Appeal that the failure to call Mr Robb diminished the cogency of ASIC’s evidence, whilst ASIC admitted that it was under a general obligation to act “fairly”, the High Court held as follows:

  1. the Court of Appeal had not identified the source of any duty to call particular evidence, nor the source of the rule which was said to apply if that duty was breached;
  2. even if such a duty were to exist, it would be expected that the remedy would lie either in the primary judge directing ASIC to call a witness or staying proceedings until ASIC did so, or if the trial went to verdict in the appellate court considering whether a miscarriage of justice necessitated a retrial; and
  3. no solution to the hypothesised unfairness could be found in requiring that the cogency of whatever evidence was brought be somehow discounted.

The High Court rejected the Court of Appeal’s reliance upon the principles in Blatch v Archer (that all evidence is to be weighed according to the proof which it was in the power of one side to have produced) and Jones v Dunkel (that the unexplained failure to call evidence entitled a Court more comfortably to draw an inference favourable to the opposing party, where that inference was otherwise available on the evidence). ASIC’s case did not depend upon inference but upon direct evidence in the form of the minutes of the February meeting.

To expect Mr Robb to admit that he had participated in the meeting and then settled board minutes which falsely recorded a resolution having been made, an outcome which would be contrary to his interests in every way, would have required cross-examiners “possessed of the most boundless and heroic optimism”. The most which could be said in relation to Mr Robb’s potential evidence was that ASIC had concluded that it was not helpful to its case. It was held that the Court of Appeal had erred in discounting the cogency of ASIC’s evidence as disputes as to questions of fact must be decided according to the evidence adduced, as opposed to some speculation as to what other evidence might possibly have been led.

The Court of Appeal’s decision was overturned and the matters have been remitted to the NSW Court of Appeal for determination of so much of the appeals brought by the individuals as relate to relief from liability and penalties.

Shafron’s appeal (Shafron v ASIC)

Mr Shafron asked the High Court to consider three questions:

  • In what respects did the statutory definition of “officer” apply to him?
  • Did he fail to exercise the relevant standard of care by failing to advise the CEO or the board that the DOCI information should be disclosed to the ASX?
  • Did he fail to exercise the relevant standard of care by failing to advise the board that the actuarial material did not take account of superimposed inflation but should have?

As to the first point, it was not disputed that Mr Shafron was an officer of JHIL by virtue of s.9(a) of the Act which specifically includes a company secretary in the definition of an officer. Shafron’s contest was that his conduct in issue was not done in his capacity as company secretary but rather in his capacity as general counsel, which role fell outside of the definition of “officer” such that the Corporation Act duties did not apply. He proceeded on the basis that:

  1. there should be a division of his duties and responsibilities between those undertaken in his capacity as a company secretary (and therefore officer) and those undertaken in his capacity as general counsel;
  2. his duties as company secretary did not extend to giving advice of the kind alleged; and
  3. he was not an ‘officer’ of JHIL in any broader sense than as company secretary.

The High Court rejected these submissions.

Whilst the High Court accepted that Mr Shafron had correctly identified that the question of a company secretary’s responsibilities is a matter of fact, the High Court did not agree that Mr Shafron’s responsibilities as a company secretary could be defined by reference to those of Mr Cameron, his co-secretary, whose role was purely administrative.

The High Court upheld the decision of the Court of Appeal that Mr Shafron’s role as company secretary and general counsel did extend his responsibilities to giving advice about and, where appropriate, to taking steps necessary to ensure compliance with all relevant legal requirements including those that applied to JHIL as a listed public company. This element had been described by the primary judge and the Court of Appeal as a duty to protect the company from “legal risk”, which extended beyond purely administrative tasks.

Indeed, in deciding that Mr Shafron’s responsibilities as company secretary and general counsel could not be compartmentalised, it was clear this was predominantly based on the fact that Mr Shafron did not lead any evidence demonstrating that he performed certain tasks in one “capacity” and other tasks in another. Perhaps if the High Court had been faced with different evidence, its finding would be different.

The High Court provided the following guidance for the proper construction and application of s.9(b)(i) of the definition of “officer”:

  • the inquiry should be directed to the role an individual plays generally within the corporation, not simply the role the person has been played in relation to the particular issue in respect of which it is alleged there has been a breach of duty, although that could also be relevant;
  • it is of assistance to determine how a reasonable person occupying the same office and having the same responsibilities would exercise the powers and discharge their duties, thus importing an objective test. Likewise it might be helpful to consider how the individual in question acted on occasions other than the one which is alleged to give rise to a breach of duty;
  • each class of persons described in paragraph (b) of the definition of “officer” is evidently different from the persons identified in other paragraphs of the definition; and
  • s.9(b)(i) distinguishes between making decisions of a particular nature (which is the role of a director) and participating in those decisions.

It was held that the idea of participation directs attention to the role that a person has to play in the ultimate decision made, notwithstanding that the decision may be made by another person or persons. In Mr Shafron’s case, he was a senior executive of JHIL and one of a group of three executives responsible for formulating the relevant proposals to restructure the company. Whilst the board made the ultimate decision, Mr Shafron was held to have participated in that decision by his acts and therefore fell within the broader definition of an officer under s.9(b)(i) of the Act.

The findings that Mr Shafron breached his duties to JHIL were upheld, and the matter was remitted to the NSW Court of Appeal for determination of penalties.

Impact

ASIC has issued a press statement welcoming these decisions, stating that they “reinforce the behaviour expected of gatekeepers in our markets such as directors” and hailing them as “already shaping corporate behaviour and … having a positive effect”. Whether this is the case remains to be seen, but we certainly agree that the decisions do help clarify the duties of non-executive directors and management below board level. Importantly, the High Court has reinforced the application of an objective standard of diligence for directors and officers of companies.

The High Court’s judgments have supported the broadening focus of regulators on non-executive directors and senior executives below board level. This will give rise to the possible exposure of a larger group of people covered under a D&O insurance policy than traditionally experienced and possibly additional groups of people (such as a company’s lawyers) seeking coverage under D&O policies.

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