The Liability of Directors under the Modern Corporate Environment

Z3434911 1 Introduction The Middleton J observation cited in the title question brings a crucial contemporary corporate governance issue into starker focus.

[1] Corporate governance is a phrase that has an undeniable ‘motherhood’ element, in that most reasonable people might understand that company directors cannot insulate themselves from liability where they take no steps to properly inform themselves concerning day to day business operations. It is the ability to establish certain parameters to define Middleton J’s ‘more than merely going through the paces’ assertion that is the profound challenge in this important corporate governance aspect. The effort to establish the requisite parameters undertaken in this essay is guided by a careful review of Corporations Act (CA) section 180 ‘care and diligence’ provisions.

[2] This review is additionally informed through its alignment with Corporate Constitutionalism theory. The conclusion that is supported by this dual emphasis is that not only is Middleton J correct in his ‘going through the paces’ observation, a director is obliged to approach their duties with considerable vigor.

Directors will escape liability in the modern corporate environment where they demonstrably took their responsibilities seriously, even when things go wrong. The Corporations Act requirement The CA provisions concerning the due care and diligence with which Australian directors are expected to discharge their obligation owed to the specific enterprise are as easy to state as they have proven difficult to apply in practice. Section 180 provides that any corporate officer or director must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were similarly situated.

[3] It can be clearly inferred from s180(1) that the circumstances or special roles of each director should be considered by the court and the objective ‘reasonable person’ standard should also be met.

[4] The reasonableness test is measured by another hypothetical reasonable director’s skills and responsibilities with similar circumstances, where the tailored degree of care and diligence for each director required reflects the company’s hierarchy of the corporate governance structure to some extent.

[5] The business judgment rule described in the companion CA s180 provision is the primary lens through which director duties will be evaluated.

[6] The section defines a ‘business judgment’ as any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

[7] Such judgment must demonstrate compliance with the overarching due care and diligence obligation, combined with evidence of four specific attributes listed under s180(2).

[8] The rule is not designed to exempt the director’s liability from failing to make a sound judgment completely, but to give a defence to those who delivered ‘reasonable but loss-generating’ business judgments made with a rational belief and due care, and in good faith.

[9] Consequently, the burden is on the directors to show the specific evidence required by the provision and their persuasive considerations because of its defensive nature. On may readily suggest that on the bare, dispassionate s180 of the CA language alone, the Middleton J title quotation accuracy is confirmed. The intricacies and occasional inconsistencies revealed in the practical CA s180 applications are often driven by the variability of phrases such as good faith and rational belief. The following examples assist in this understanding. Specific examples The statutory requirements for directors under CA s180 are basically similar to what they are imposed under case law. The s180 duties are also better understood when placed against the broader implications that flow from the director-corporation relationship.[10] The case law confirms that directors owe a fiduciary duty to the corporation, as endorsed in cases such as ASIC v Rich[11], and more generally in the High Court of Australia decision in Chan v Zacharia[12]. The fiduciary duty injects a further element of higher obligation than that inspired by a person regarded as merely going through the paces.

The leading Australian authority Whitehouse v Carlton[13] describes the fiduciary duty as both non-delegable and non-negotiable.[14] The subjective breach of duty test confirms that a director will avoid personal liability where the decision reflects their honest but mistaken belief that when made, the anticipated results the decision would generate were seen as consistent with the company best interests.[15] It is equally important to appreciate that there are specific instances where the director decision may trigger both s180 consequences and other liabilities.[16] An example is s588G[17] of the CA personal liability imposition where the director permits the company to incur debt at a time after the director reasonably knows the enterprise is insolvent, or is likely to become insolvent.[18] In her examination of the Australian business judgment rule evolution, Du Plessis notes its inspiration as derived from earlier English appellate authority.[19] She places specific emphasis on the dicta extracted from Re Smith and Fawcett Ltd[20] in this respect, where directors are mandated to exercise their discretion “…bona fide in what they consider — not what a court considers — is in the interests of the company”.[21] This seminal position has been interpreted to mean that the business judgment rule reinforces the proposition that courts will not assume the function of being the ultimate arbiter of commercial decisions. It is important to understand that company directors ought not to be found legally responsible on the sole basis that a court later disagrees with the wisdom of their actions. This is a sound approach to the s180 business judgment rule for two reasons. It fairly recognises that no business, no matter how shrewdly operated or resolutely managed, can possibly control or anticipate every commercial variable.

There are often forces larger than the company at work; factors such as international financial markets volatility, interest and currency exchange rates, and government policy initiatives can all play an unforeseen role in business performance.[22] The second reason is directly connected to the s180 requirements – the law ought only to impose a standard, namely reasonableness that the director can satisfy through efforts any rationale observer is equipped to assess. The standard is not one of superhuman expectation. Harlowe’s Nominees[23] makes this point effectively, where the Court observes that the right and duty of “…deciding where the company’s interests lie [and] … their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review by the court”.[24] Du Plessis additionally observes that unlike the business judgment rule scope as observed in the United States, director protections in s180 are inherently more limited. She argues forcefully that Australian directors are not afforded a truly safe harbour from liability unless the good faith and rational judgment tests are satisfied. Corporate Constitutionalism Legal and economic analysis had been the predominant frameworks to review and examine corporate law and corporate governance over the years where the contractual feature reflects its private and individual nature in the context of corporate governance.[25] Although the economic analysis successfully developed an institutional account of relevant laws which regulate companies, its individual and market-oriented approach has been criticised primarily due to lack of responsiveness to political and social concerns.[26] Therefore, s180 under the contractualism framework only requires the directors to fulfil the obligations in the contract without considering other stakeholders’ rights and interests affected by their decisions.[27] Without denying the reasonableness of economic analysis approach and private nature of corporate law, Stephen Bottomley creatively introduced and implemented a corporate constitutionalism framework by adapting the constitutionalist ideas in political and social theory to give a more comprehensive explanation of corporate governance.[28] In its formulation, corporate constitutionalism is defined by three key features: dual decision-making, deliberative decision-making, and the separation of powers.[29] It can also be crystallised that the board of directors and general meeting should be responsible for their decisions by applying a separation of decision-making powers to corporate governance (accountability), where any disputes with regards to the corporate decisions are required to be solved by deliberation (deliberation), and all shareholders are entitled to contest the decisions to ensure they stands for their interests (contestability).[30] Under dual decision-making structure, directors’ abilities to make decisions are restrained constitutionally by the considerations of majority members’ interests which positively benefit the corporate governance.[31] Furthermore, deliberation feature can not only advance the quality in decision-making process but also contribute to protect the members’ best interests, where the separation of powers provide alternative mechanism to enhance the accountability and monitor the corporate governance process.[32] Each of these constitutionalism features is rooted in the notion that decision-making spanning a vast potential topics range is the essence of corporate life.[33] For this reason, Australian law pays significant attention to the rules, doctrines and standards that influence corporate decision-making. These have an informational component, such as the need to disclose annual account and prospectuses.

The CA provisions also prescribe procedural rules such as board meetings, and s180 requirements discussed above.[34] For these reasons, corporate constitutionalism is also a concept that explains the importance of structure and process, as opposed to substantive legal doctrine. Among various criticisms towards corporate constitutionalism approach, the fundamental limitation is that most companies which make any business decision in order to maximise profits may be driven to ignore the public policy concerns.[35] Nevertheless the framework is an important supplement to the existing corporate law theory which considerably improves the integrity and quality of corporate governance.[36] Overall, constitutionalism delivers an alternative account of corporation law to take into account non-shareholder and other public interests in the process of corporate decision-making. The Rich[37] impact Legg and Jordan suggest that prior to the ASIC v Rich[38] decision, the business judgment rule was rarely invoked in Australian director breach of duty claims.[39] The prevailing academic view was the rule added little to the existing directors’ duties law. The ready conclusion was offered that where the facts establish a director failed to exercise his corporate duty of care, the company would ipso facto negate the business judgment rule.[40] In Rich, the Court plumbed deeper into the rule rationales. The Court decided to approach the question as one of “….how much further the concept of business judgment is extended into the realm of management, organisation and planning”.[41] This key phrase illustrates how the Court was prepared to take the examination. Through its focus on the decision-making occasion, as opposed to the director’s general state of knowledge, the Court characterised the director as one obliged to become informed about the subject matter of the decision prior to making it. The Court stresses that the s180 qualifying words, ‘to the extent they reasonably believe to be appropriate’, must convey the idea that protection may be available even if the director was not aware of the available information material to the decision, so long as the director reasonably believed appropriate steps were taken on the decision-making occasion to be properly informed concerning the subject matter.[42] It is apparent that this approach is largely consistent with the corporate constitutionalism as described by Stephen Bottomley.[43] The prudent director is revealed as one that understands and adheres it the proper procedures; once followed, the director should enjoy significant protection from liability claims. Conclusion As noted in the initial examination of the s180 languages, it would be difficult to imagine a director being able to discharge their stated obligations if their role was merely ornamental, or one characterised as simply going through their paces.

The business judgment rule as taken from the English authorities and adopted for use under s180 of the CA auspices places significant obligations on Australian directors, ones that are made more prominent when fixed against their fiduciary duties backdrop. Neil Young pointed out in his article with regard to corporate governance that there are considerable numbers of directors who should have great knowledge and understandings of their companies are not familiar with the operations or strategies of the companies.[44] As a result of that, it was suggested that a ‘responsive regulation’ approach which lays much heavier penalties even criminal sanctions for the breach of directors’ duties should be used to enhance the compliance of the CA and achieve a better balance between s180(1) and (2).[45] It is equally apparent that the corporate constitutionalism theory that also exerts its influence over how director obligations ought to be understood affords further liability protection to those directors that assiduously follow correct board procedure in their decision-making processes.

[1] ASIC v Healey [2011] FCA 717.

[2] Section180(1), Corporations Act 2001 (Cth).

[3] Andy Gibson, Business Law (Pearson Australia, 6th edition, 2013), pp232-236.

[4] Emillios Kyrou, “Directors’ Duties, Defences, Indemnities, Access to Board Papers and D&O Insurance Post CLERPA” (2000) 18 C&SLJ 555, p558.

[5] Neil Young, “Has directors’ liability gone too far or not far enough? A review of the standard of conduct required of directors under sections 180-184 of the Corporations Act” (2008) 26 C&SLJ 216, p220.

[8] Section180(2), Corporations Act 2001 (Cth).

[7] Section180(3), Corporations Act 2001 (Cth).

[8] Section180(2), Corporations Act 2001 (Cth).

[9] Sarah Worthington, “Reforming Directors’ Duties” (2001) 64 Mod LR 439, p450. [10] Brian Horrigan, “Directors’ Duties and Liabilities – Where Are We Now and Where Are We Going in the UK, Broader Commonwealth, and Internationally?” (2012) 3(2) International Journal of Business and Social Science1, p1. [11] [2009] NSWSC 1229. [12] [1984] HCA 36. [13] (1987) 162 CLR 285. [14] Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285. [15] R P Austin and I M Ramsay, Ford’s Principles of Corporations Law (LexisNexis, 15th edition, 2012), Pt I.2 and Pt III.6. [16] Section9, Corporations Act 2001 (Cth); as discussed in Taylormaid Marine Industries Pty Ltd v Beaurepaire & Ors (1987) 5 ACLC 253. [17] Section588G, Corporations Act 2001 (Cth). [18] J Jean and Du Plessis, “Open Sea or safe harbour? American, Australian and South African business judgment rules compared: Part 1” (2011) 32 Company Lawyer 345, p347. [19] Ibid, p348. [20] [1942] Ch 304. [21] Ibid. [22] Andy Gibson, Business Law (Pearson Australia, 6th edition, 2013), pp234-236. [23] Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483. [24] Ibid, p493; see the similar English reasoning in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, p835. [25] Stephen Bottomley, The Constitutional Corporation: Rethinking Corporate Governance (Ashgate, 2007), Chapter2, pp 19, 25, 26, 29. [26] Angus Corbett and Peta Spender, “Review Essay: Corporate Constitutionalism” (2009) 31 Sydney Law Review 147, pp148, 149. [27] Stephen Bottomley, “From Contractualism to Constitutionalism: A Framework for Corporate Governance” (1997) 19 Sydney Law Review 277, p289. [28] Ibid, p296. [29] Ibid, p298. [30] Neil Andrews, “Reviews and Current Developments: Putting the politics back into corporate law: A review of Stephen Bottomley’s The Constitutional Corporation: Rethinking Corporate Goverance” (2007) 21 Aust Jnl of Corp Law 161, pp162-164. [31] Stephen Bottomley, “From Contractualism to Constitutionalism: A Framework for Corporate Governance” (1997) 19 Sydney Law Review 277, p300. [32] Ibid, pp 306-207, 309. [33] Angus Corbett and Peta Spender, “Review Essay: Corporate Constitutionalism” (2009) 31 Sydney Law Review 147, p149. [34] Ibid, p150. [35] Stephen Bottomley, “From Contractualism to Constitutionalism: A Framework for Corporate Governance” (1997) 19 Sydney Law Review 277, p313. [36] Angus Corbett and Peta Spender, “Review Essay: Corporate Constitutionalism” (2009) 31 Sydney Law Review 147, p154. [37] ASIC v Rich [2009] NSWSC 1229. [38] [2009] NSWSC 1229. [39] Michael Legg and Dean Jordan, “The Australian Business Judgment Rule after ASIC v Rich: Balancing Director Authority and Accountability” (2013) 34(2) Adelaide Law Review 179, pp179-181. [40] ASIC v Rich [2009] NSWSC 1229, p1231. [41] Ibid. [42] Ibid, p7284. [43] Stephen Bottomley, The Constitutional Corporation: Rethinking Corporate Governance (Ashgate, 2007), Chapter2. [44] Neil Young, “Has directors’ liability gone too far or not far enough? A review of the standard of conduct required of directors under sections 180-184 of the Corporations Act” (2008) 26 C&SLJ 216, p231. [45] Ibid, pp230-231.

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