Duty of Care and Diligence
We write this memorandum of advice to you in relation to the issues which are raised through the facts provided by you. By going through the facts of the situation we think that you require advice primarily on three specific Issues. These issues are as follows
- The potential breaches in relation to the duties owed by you as a director of the company
- The potential breaches in relation to the disclosure obligation owed by you as a director of the company
- The defenses on which you may rely upon in the relation to the breach of duty and disclosure obligations
A director of a company is imposed with duties under statutory provisions and common law. The company which is in context (LulLaBy) is a public company which has been registered with the ASX for eight years thus the provisions of The Corporation Act 2001 (Cth) (CA) are applicable in the given situation. The CA is the primary statue which governs corporate affairs in Australia.
The following general duties have been provided through the CA towards any person who is a director of the company within the meaning of Section 9 of the CA.
This duty imposes an obligation on the directors or other officers of an organization to depict a degree of “care and diligence” while they discharge their functions associated with the organization. “care and diligence” in the given situation is measured through a “reasonable person standard”. To make it simple for you a director or officer of a company has to discharge his duties in a way which a reasonable person may be expected to discharge in a similar role as the original director. If you have acted in the same way as a reasonable person (director) would have done if he was in your position then the court would deem that you have complied with the duty. On the other hand if the hypothetical reasonable director who was in your position would have not taken the actions which you have taken it would be considered as a breach of the duty. The same form of duty is also imposed on the directors of the company through the provisions of common law. The duty has been discussed on various occasions in Australia in a number of cases by the courts. Few of the cases which involve the discussions of the duty and are relevant to your situation have been included in this memorandum of advice for your reference. We would like you to know that this duty may also be violated if you have made your company enter into a transaction which is of a very risky nature if there is no or very little prospect of profits for the company. In addition if the you as a director have not informed the board about the nature of the transaction you may also be liable for the breach of this duty.
Duty to Act in Good Faith and Best Interest of the Company for a Proper Purpose
In the case of Daniels & Ors v Anderson & Ors [1995] 13 ACLC 614 it had been stated by the courts that irrespective of their background the director have a duty to exhibit a greater degree of care and diligence. Although the directors generally have an expertise they have to have greater care towards the organization than only representing their expertise. The directors are required to be informed about all aspects in relation to the business of the company.
ASIC v Hellicar [2012] HCA 17 is a case where the directors have been held liable for the breach of section 180 of the CA by approving the CEO to make misleading announcement in relation to the ASX. Further in the case of Australian Securities and Investment Commission (ASIC) v Cassimatis (No. 8) [2016] FCA 1023 the court held that the directors are liable for the loss of reputation of the company as well, if its results out due not observing care and diligence in their actions. Another case where the duty of care and diligence has been discussed is the case of ASIC v Adler and 4 Ors [2002] NSWSC 171. In this case the managing director of the company had been held to violate the provision of section 180(1) of the CA as there was a failure on his part ensure that he properly safeguards a loan which has been sanctioned by his company to a third party which was not in best interest of the company. This was because a reasonable person in the same position would have discussed the proposal with the board before the loan had been provided.
In the given situation you have provided us with the facts that you were on the verge of retirement and undertook a arrangements in relation to the a transaction on behalf of the company. You had the knowledge that if all things goes well than the share price of the company will be increased before your retirements. The deal is in relation to an “infrastructure investment in fiber optic cables and multi-year continuous maintenance contract in the national broadband network (NBN)”. However you also had the knowledge that the investment needs a considerable financial outlay and it was not sure whether the company had such financial resources. The deal had been entered by the company under your leadership. In this given situation it is very likely that you have contravened the provisions of section 180(1) as a reasonable director who had knowledge that it was not sure that the company had the required financial resources in relation to the deal would have not entered into the deal. You may be liable for the breach of civil penalty provisions under section 1317E and may be imposed with ban for managing corporations in the future and with financial penalties as well.
Duty to Avoid Improper Use of Position and Information
The primary requirement which the CA imposes on the directors of the company is that they must act in “good faith and best interest of the company for a proper purpose”. Under this duty is also covered the duty under common law to avoid a conflict of interest. However if a conflict of interest comes into the context then the directors give importance to the company’s interest rather than self interest. The under section 181 mirrors the duty of trust and fidelity. One of the recent cases where the court discussed about the breach of this duty is the case of Jones and Ors v Invion Ltd and Anor [2015] QCA 100. In this case the court held that directors who acted on behalf of the company to pursue personal interest rather than the interest of the company have violated the provisions of section 181 of the CA.
According to the facts provided by you to us you were on the verge of retirement and when you undertook a arrangements in relation to the a transaction on behalf of the company. You had the knowledge that if all things go well than the share price of the company will be increased before your retirements. However because of the deal you have been able to attain a lucrative retirement package. The package contain a high amount of money and allegations can be made against you that you have entered into the deal in order to pursue person interest in relation to the retirement package. It can be argued that you had knowledge of the fact that if you secure a deal before you retire you will get a lucrative retirement package and thus you were not bothered about the feasibility of the deal and the interest of the company. Thus where the interest of the company is not prioritized over personal interest you may be liable for the breach of the duty under section 181 of the CA.
Under this duty the directors are required not to make an improper use of the position they possesses in the company to gain a personal advantage for themselves or for any other person or to the detriment of the organization. The case of Forty Two International Pty Limited v Barnes [2014] FCA 85 is a primary case where the breach of this duty has been discussed. In this case the directors were found to use their position in the company to their own advantage of securing additional $16 million earn out payment and bringing detriment to the company. In the given situation it can be stated that you may also be held for the breach of this duty as it may be argued that you misused the position which you had in the company to gain personally and case detriment to the company.
Disclosure Obligations
Under this duty the directors are required not to make an improper use of the information position they possesses in the company to gain a personal advantage for themselves or for any other person or to the detriment of the organization. However as per the facts which have been provided by you we come to the conclusion that this duty will not be potentially violated by you.
We would in addition like you to know that if you are found to actually have violated the above discussed duties you may be liable for the breach of civil penalty provisions under section 1317E and may be imposed with ban for managing corporations in the future and with financial penalties as well.
You may be held liable for a criminal offence under the criminal code section 6.1 if it is found have recklessly violated the provisions of the above discussed duties. However we would like you to know that as per your situation the section has not been invoked by you.
The CA sets out specific disclosures obligations which the directors of a company operating in Australia and registered with the ASX have to comply with.
Under the provisions of section 191 of the CA it is the duty of the directors of an organization to make continuous disclosure in relation to any personal interest they may have in a transaction to the board of directors. The provisions of this section have also been discussed in the case of Forty Two International Pty Limited v Barnes [2014] FCA 85 where the directors of the company were held liable for the breach of section 191 by not disclosing to the board the personal interest they had in the transaction. In the given situation as per the facts provided by you an allegation may be brought against you that you had a personal interest in the transaction (lucrative retirement package) and you failed to disclose such interest to the board of directors. Thus you may be held liable for the breach of disclosure obligation which you have under this section.
According to the provisions of Section 674 of the CA it is the obligation of a listed organization to make continuous disclosure of information which may have an impact upon the value or market price of the shares of the company. The requirement finds it basis on the common law principle that all investors of the company must be provided with timely and equal access to material information in relation to the company. The information when disclosed in a timely manner provided protection to the investors and subsequently enhances the reputation of the market. Statutory liability is imposed on the directors of the organization for make an breach in relation to the listing rules where any material information through which the market price many be affected is not made available to the public. The rule is also provided through listing 3.1 of the ASX.
Conclusion
In the case of Riley v Jubilee Mines NL [2006] WASC 199, the court awarded damage to the shareholders of the company where the directors were not able to comply with the provisions set out in section 674(2) of the CA. In another Taylor v Telstra Corporation Ltd [2007] FCA 2008 which was a class action the defendant organization made a settlement to pay its shareholders an amount of $5 million for not being able to comply with the disclosure obligation.
Another significant case in relation to the breach of disclosure obligation is the case of Fortescue Metals Group Ltd v Australian Securities and Investments Commission & Anor [2012] HCA 39. Although in this case the defendant company was held not to violate the provisions of section 674 it has been stated by the court that a the directors of the company may are liable for the breach of their duties if they have failed to comply with the disclosure obligations on relation to the organization.
The provisions of section 674(2) of the CA has specifically provided that a listing entity has to notify the market operator which in most cases is the ASX about any information which is may not be generally available to the public and in a information which would be reasonable expected by a reasonable person that if it was available generally it would have a material effect on the value or price of Enhanced Disclosures securities of the company. Further we would also like you to know that it has been provided through the provisions of section 674(2A) of the CA that any person who is found to be “involved” in the contravention made by a listed entity is also liable for the breach of disclosure obligations in relation to the organization.
Further ASX Listing Rule 3.1 imposes an obligation on the company that as soon as it comes to know or becomes aware about an information related to it, which would be held by a reasonable person as an information which would have a material effect on the value or price if the securities of the entity, it must immediately convey such information to the ASX.
Moreover an entity is deemed to be aware of the information in case an executive officer or director ought to have or has got possession of the information in course of discharging their duties which they owe as directors or officers of the company as per ASX Listing Rule 19.12.
In the given situation it has been provided by you in the facts that although there have been uncertainty in relation to the financial capabilities of the company towards the transaction the company had carefully refrained from disclosing to the market the degree of financial commitment. Further it has also been provided through the facts that as the company would not be able satisfy its financial commitments under the contract, they provided 6 million AUD worth of shares to the infrastructure company. In addition this disclosure was also not made to the ASX.
In the given situation it is evident that where the company has not provided the information about not being sure about its ability to satisfy the financial commitments, such information would not be generally available to the public and the information would be reasonable expected by a reasonable person that if it was available generally it would have a material effect on the value or price of securities of the company. Thus the company has violated its disclosure obligation.
Further the disclosure obligation has been violated by the company by not letting the ASX know about the fact that as the company was not be able satisfy its financial commitments under the contract, they provided 6 million AUD worth of shares to the infrastructure company. This information would also not be generally available to the public and the information would be reasonable expected by a reasonable person that if it was available generally it would have a material effect on the value or price of securities of the company. Thus the company has violated its disclosure obligation under section 674(2) of the CA.
Further as the director of the company it was your duty to take reasonable care in relation to the affairs of the company. This means that of the organization has violated the provisions of section 674(2) you are also held liable for the violation of the section under section 672(2A). This is because it has been provided through the provisions of section 674(2A) of the CA that any person who is found to be “involved” in the contravention made by a listed entity is also liable for the breach of disclosure obligations in relation to the organization. This can be further emphasised as all such events took place before your retirement while you have been the director of the company.
Thus we would like you to know that upon the analysis of the facts provided by you it is likely that you may be held liable for the breach of disclosure obligations which a organization listed with the ASX owes under the CA .
DEFENCES WHICH MAY BE AVAILABLE FOR YOU
The defences which we have identified for you in relation to the above discussed breaches are as follows
- The business Judgement rule under section 180(2) and common law
- Exceptions to the disclosure obligations
- Section 1318 and Section 1318S of the CA
The provisions in relation to the Business Judgment Rule (BJR) are provide under the provisions of section 180(2) of the CA.
The BJR is applicable against an allegation for the breach of the duty of care and diligence under section 180(1) of the CA and not other sections of the Act. The purpose of the rule is to avoid any unwanted burden upon an entrepreneurial activity. It is provide through section 180(2) that where a business judgement has been made by the director of a company it is held that the care and diligence requirement is met in relation to the judgement where
- The judgement is taken for a proper purpose and good faith
- It does not have any personal material interest in relation to its subject matter
- The decision had been made after the subject matter of the judgement have been reasonably being informed of by the directors like a reasonable director
- The director had a rational belief that the decision is taken in the best interest of the company.
The case of Australian Securities and Investments Commission v Mariner Corporation Limited [2015] FCA 589 is a recent example where the business judgement rule had been utilized by the court. In this case the directors had been provided protection under the rule against an allegation for the breach of the duty of care and diligence. In this case the court held that the judgement taken by the directors in context was in good faith and for a proper purpose. They did not have any personal material interest in relation to its subject matter of the decision. The directors informed themselves about the subject matter of the decision like a reasonable person and had a rational belief that the decision is taken in the best interest of the company.
Further it had been quoted by the judge in the case of Vrisakis v Australian Securities and Investments Commission (1993) 9 WAR 395, that the only fact that there was participation by the directors of the company which involved foreseeable harm does not means that the directors have done a failure in relation to exercising a reasonable degree of care and diligence while discharging their duties. The issue that whether the duty of care and diligence has been complied with by the directors of the company in the situation can be only addressed by analysing the balance of foreseeable risk of harm against the benefit which the organization would have gained in relation to the conduct of the directors.
Another significant case in relation to the application of thee business judgement rule in Australia is the case of Australian Securities and Investments Commission v Rich (2009) 236 FLR . This case changed the way in which the BLR was applied in Australia. In this case the directors of the company had been provided the protection under the provisions of section 180(2) of the Act against the allegation of the ASIC that they violated the provisions of section 180(1) of the CA. The allegation was that the directors had failed to exercise due care and diligence as they did not keep the board of the company informed sufficiently about the material information in related to the actual financial condition of the company particularly in the periods which lead towards the cancellation of “proposed rights issue”. However the court stated that the directors had informed themselves about the subject matter of the decision and reasonably believed that the decision was in the best interest of the company.
Through the application of the above discussed cases it can be stated that you may be able to rely on the provisions of the business judgement rule as stated through section 180(2) of the CA. You can make a valid claim that your retirement was merely incidental to the event and you generally believed that the decision was taken in the best interest of the company. You as a reasonable person had believed that the decision is going to enhance the share price of the company and this is the only reason you had indulged in the decision. In addition you may also state based of the Vrisakis v ASIC case that upon analysing the balance of foreseeable risk of harm against the benefit which the organization would have gained in relation to your conduct the weight of benefits is more than the risk.
It has been provided by section 674 (2B) of the CA that a person is not liable to the breach of the disclosure obligation if they had taken all reasonable steps in the situation to ensure that the disclosure obligation is complied with by the organization. In addition they had a belief on reasonable grounds that the compliance of the listing rules was being made by the company.
In the given situation as per the facts provided by you it can be stated that there has been a deliberate failure on the part of the organization and you with respect to the disclosure obligations. Thus the above discussed defences in relation to the disclosure obligations would not be applicable in the case. However there are a few other defences which may help you in the situation which are discussed below.
Section 1318 and Section 1317S of the CA
It has been provided through the provisions of section 1317S of the CA that relief from civil penalty provisions may be claimed from the court. However the section does not provide relief for an offence under the Act. the court may grant a relief if the person brings in eligible proceedings and the court comes to a conclusion that although the civil penalty provisions have been violated the person acted honestly and the person may be excused from the contravention if the court deems fit under the circumstances of the case. The court may provide relief wholly or partially in relation to the penalty imposed against the person. The same kind of relief is available under the provisions of section 1318 of the CA. Thus these defences may help you in the situation.
Hope we have been able to address your concerns for the issues. If you have any queries in relation to the advice feel free to contract us.
References
ASIC v Adler and 4 Ors [2002] NSWSC 171
ASIC v Hellicar [2012] HCA 17
Australian Securities and Investment Commission (ASIC) v Cassimatis (No. 8) [2016] FCA 1023
Australian Securities and Investments Commission v Mariner Corporation Limited [2015] FCA 589
Australian Securities and Investments Commission v Rich (2009) 236 FLR
Daniels & Ors v Anderson & Ors [1995] 13 ACLC 614
Fortescue Metals Group Ltd v Australian Securities and Investments Commission & Anor [2012] HCA 39
Forty Two International Pty Limited v Barnes [2014] FCA 85
Jones and Ors v Invion Ltd and Anor [2015] QCA 100
Riley v Jubilee Mines NL [2006] WASC 199
Taylor v Telstra Corporation Ltd [2007] FCA 2008
The Corporation Act 2001 (Cth) s.
Vrisakis v Australian Securities and Investments Commission (1993) 9 WAR 395
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