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Commercial and Corporate update: A public company director’s lot is not a happy one

May 10, 2012

Why would you want to be a public company director?

One could be forgiven for thinking that a directorship with an Australian public company has become a poisoned chalice rather than a cushy sinecure for those who have done the ‘hard yards’ in the earlier years of their business careers.

Following the recent decision in the Centro Properties case, there have been newspaper reports of its effect on directors of Chicken Little proportions: the boardrooms of Australia will empty, they cry; the standards expected of directors have been set way too high, they argue. You get the picture.

So what is the fuss all about? A trio of cases will explain.

Centro Properties – Directors’ fail to detect errors in the Annual Report

In Centro Properties, ASIC alleged that the directors had breached their duties as directors and certain financial reporting obligations imposed on them by the Corporations Act 2001 by failing to properly classify in the 2007 Annual Report, certain short-term liabilities and guarantees of those liabilities as current instead of non-current. The error stemmed from changes being made to the accounting standards that were under way at the time.

In their defence, the directors argued they relied on sound internal processes, on experienced and competent management and on top tier auditing advice to ensure the Annual Report was accurate. Unfortunately, none of these safeguards revealed the errors.

ASIC’s star witness was ‘Blind Freddy’ whom, it argued, would have picked up the errors. In this case, ASIC argued that the directors were just plain negligent in carrying out their duties.

The Trial Court agreed and found for ASIC. The Trial Court found that while directors were entitled to rely on information provided to them by others and were not expected to personally check all information used to compile the financial statements, they were obliged to bring an enquiring and questioning mind to the task of verifying the accuracy of the financial statements and that ultimately the buck stopped with them. The directors could not be heard to complain about the volume of information and documents they had to consider as it was within their power to control that flow.

James Hardie – The continuous disclosure obligation

In James Hardie, ASIC took the Board to task over information released to the market about the funding for the Foundation established to handle claims by asbestos victims. While the Trial Court found against all of the directors, the Court of Appeal overturned that decision and found that only two of the directors had a case to answer; one for failing to alert the CEO and the Board to a continuous disclosure obligation and the other for failing to alert the Board about the basis upon which a key cash flow model for the Foundation had been reviewed.

Fortescue Metals Group – Andrew Forrest runs into trouble over Chinese contracts

Making up the trio is Fortescue. This case also concerned the application of the law concerning continuous disclosure and directors’ duties. The relevant announcements to the market reported that Fortescue Metals Group had entered into important contracts with Chinese companies. At issue was whether the ‘contracts’ were contracts enforceable at law and as a flow on, how had the market been effected by the announcements. Investors in Fortescue Metals Group have done very well and regardless of whether the Chinese contracts were enforceable at law, the market was not adversely affected.

The Trial Court found for Fortescue Metals Group and Mr Andrew Forrest but this decision, too, was overturned by the Court of Appeal.

What do these cases mean for public company directors?

The terrain for directors following these cases remains uncertain. In Centro Properties, the Court is still to rule on penalties and may be appealed while in James Hardie and Fortescue, appeals to the High Court are pending.

Directors need to appreciate that they can escape being sanctioned by a court for a breach of duty or statutory obligation simply by pleading that they acted ‘honestly’. ‘Honest’ conduct will however provide a platform for a director to seek relief from liability once found ‘guilty’ of a breach of duty, but the cases show that the Courts make relief orders very sparingly.

There is no doubt that public company directors have never faced greater scrutiny from ASIC, shareholders and class action activists. The challenges for public company directors are obvious but since they hold these positions as stewards of ‘other people’s money’ and livelihoods — namely, the shareholders, employees and in some instances, creditors — it is not too much to expect that they live up to the highest standards of care and responsibility.

What should public company directors do now?

It is vitally important that public company directors carefully review their internal processes for receiving information, professional advice and risk management in light of the issues revealed by Centro Properties, James Hardie and Fortescue. Efforts must also be redoubled to ensure that advice from management and external professionals are not simply relied upon but are questioned and tested.

More information

For further guidance on the issues raised in this article, please contact Jeremy Goldman on (03) 8600 8886 or jgoldman@kcllaw.com.au.

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