Submission to Laurie Glanfield Director General Department of the NSW Attorney Generals Issu
- Date:17 Mar 2005
- Type:Policy & Advocacy: Submission
Issues arising from the James Hardie matter
1 OVERVIEW
AICD believes that the claims of asbestos sufferers should be met and supports the announced settlement between James Hardie, the unions and claimants under which this outcome will be achieved. At the same time, it is important that sweeping changes to existing law are not made in response to the very special circumstance of James Hardie that would have unintended negative consequences for thousands of ordinary Australian companies and for the employment prospects of Australian workers and the resources available to the wider community.
James Hardie is a unique case. Any proposal to alter the fundamental concepts of corporate law on which our economy is based must be approached with caution, and should only be effected (if at all) after widespread consultation. That consultation was not possible in the context of the Special Commission of Inquiry and David Jackson QC properly generally refrained from making specific recommendations for change, while discussing areas of particular difficulty in the James Hardie case. The Special Commission did not have available to it the range of skills available to the Corporations and Markets Advisory Committee (CAMAC) or the Australian Law Reform Commission and AICD considers that that more balanced process is required for consideration of wider law reform proposals. Generally the parties to the Special Commission were advocates for particular interest groups, and there was no real voice to raise issues such as the economic impact on the wider community of some of the law reform advocated for before the Commission. It is dangerous to develop law reform primarily through the perspective of the James Hardie case which is unique and AICD would argue not indicative of wider systemic failure.
In this paper, AICD looks at the areas of concern which arose in our discussions with you.
2 Social responsibility and directors duties
2.1 Generally accepted position
Directors of Australian companies are required to act in the best interest of the company and for a proper purpose, both under case law and the Corporations Act.
The Australian corporate community overwhelming accepts that the long term "best interests" of a corporation may only be accurately identified in the context of its position in the community and by recognising a variety of stakeholder interests. A typical example of the statements now to be found routinely in the annual reports and corporate governance pronouncements of Australian listed companies. Commonly, these statements will provide that each director will at all times act in the interests of shareholders of the company and of the company as a whole, and may have regard to the interests of employees and customers of the company and the community and environment in which the company operates.
This principle has such widespread acceptance because all empirical evidence demonstrates that those companies which fail to respect the interests of their broader stakeholders will inevitably suffer in the marketplace, many to the extent of going out of business.
2.2 No need for generalised "social responsibility" duty There is no need to impose additional, generalised, "social responsibility" duties on directors and to introduce such a statutory duty is potentially very damaging.
While there is generally an identity of interest between a company, its shareholders and other stakeholders, these interests can sometimes be in tension. This is the reason for a range of laws (eg, environmental, occupational health and safety, superannuation) which change the balance on specific issues in accordance with current societal expectation. Such specific laws draw a clearer line for directors in those cases where interests other than shareholders are to be preferred, and insulates them against claims by shareholders for failure to guard their interests properly.
Although there is no final conclusion to the James Hardie matter, the Australian community as a whole has so far acted to ensure that the interests of all stakeholders in the James Hardie group have been recognised, and ultimately accommodated in the settlement which has been announced. This included efforts by the NSW Government, in implementing the Special Commission of Inquiry and undertaking the legal costs review and the unions and those affected by asbestos related disease, in voicing their concerns publicly.
The community response to the James Hardie case in Australia has demonstrated that any attempt to insulate a parent company from the legitimate claims of employees or consumers of subsidiary companies are entirely unrealistic if the enterprise is to continue in business.
You may ask, if this is true, what would be the harm of imposing a generalised "social responsibility" duty on directors? AICD considers that the harm lies in the very generality of the duty.
Changes to the law which unsettle the fundamental "compass" of directors – the fact that they are stewards of other people's money – will discourage investment in Australia and prejudice the legitimate interests of the millions of Australians who hold shares directly or through managed investment schemes or pension funds. Ultimately that works to the disadvantage of all Australians, whether or not they hold shares, by limiting investment and thereby limiting employment opportunities and narrowing the tax base in Australia.
It would introduce the need for frequent decisions by directors that would have to trade off social outcomes for shareholder interest.
Statutory intervention that provided legal status to the recognition of each of those interests would be an extraordinarily complicating factor, and would place directors in an impossible situation since there is no practical way to reconcile all such interests.
Directors' actions would also be judged largely in hindsight, not against the community standard prevailing at the time of the directors' actions, since cases often take a number of years to be finally determined.
Insurers will be less likely to provide insurance because of the increasing likelihood of directors being sued.
Company funds may well be dissipated in opportunistic or political "cause" inspired litigation.
It will compromise the willingness of well qualified people to act as a director.
2.3 Imposing a duty on directors of Australian companies would not affect James Hardie NV
James Hardie is now, for all practical purposes, a US based and controlled operation. This has no doubt complicated and delayed a negotiated settlement, due to concerns that directors of James Hardie may feel about being sued by investors in the litigious US market.
However, changing laws affecting directors of Australian companies – to create a new "social responsibility" duty – will not alter this or assist the claims of those affected by asbestos related disease.
2.4 Is there any useful clarification? AICD believes it would be a helpful if the role and duties of a director were elucidated. In this way, it would become clearer that it is legitimate for directors to consider stakeholders' interests in the pursuit of acting in the interests of the company as a whole. And, it would highlight that it is indeed a prudent step for a director to take in his or her decision making. This approach is illustrated in Professor Bob Baxt's 17th Edition of the "Duties and Responsibilities of Directors and Officers" Professor Robert Baxt, "Duties and Responsibilities of Directors and Officers", 17th Edition, Australian Institute of Company Directors, 2002.:
"The yardstick by which a director may safely judge his or her own actions at times of difficulty and conflict is this:
'Taking account of all the circumstances, is what I propose to do in my honest belief in the best interests of all the shareholders of the particular company of which I am a director?'"
Of course, Directors should also be encouraged to obtain a sound understanding of their role and duties. AICD has actively provided such education for many years.
3 Other areas of law reform
The Special Commission of Inquiry – either explicitly or by its recitation of its findings – and the Court of Appeal in New South Wales in Edwards v Attorney General [2004] 22 ACLC 1,177 highlighted a number of other areas for consideration and community consultation for change to the Corporations Act.
3.1 Give the court power to approve future actions of directors – expand section 1318(2) Section 1318
Section 1318 allows a court wholly or partly to relieve a director from civil liability for negligence, default, breach of trust or breach of a specific directors' duty if the court decides that the director has acted honestly and that, in the circumstances, the director deserves to be excused. Section 1318(2) allows relief to be granted when a director 'apprehends' that a claim will be made against him or her for, among other things, negligence or breach of duty.
The James Hardie case, through the decision of the NSW Court of Appeal in Edwards, has focussed attention on the shortcoming of section 1318(2) of the Corporations Act. The court found that section 1318(2) only gives the court jurisdiction to protect directors in respect of past conduct and not future actions, even when the future actions are the same as the past conduct sought to be relieved.
It is noteworthy that while all other corporate administrators See section 424 for controllers (which includes receivers), s467D for administrators and sections 479(3) and 511 for liquidators, including provisional liquidators by section 472. have various rights to approach the court for advice or directions about future conduct under the Corporations Act, and trustees have some rights under trustee legislation of the various States, directors alone lack this facility.
Edwards case
In Edwards, an application was made by the directors of Medical Research and Compensation Foundation, a company limited by guarantee (Foundation) established to act as trustee of the fund created by James Hardie to compensate people with asbestos related disease as a result of exposure to James Hardie asbestos products. The application was also made by them as directors of Amaba and Amaca, the former James Hardie subsidiaries (now owned by the Foundation as a result of 2001 scheme of arrangement) which had conducted the James Hardie asbestos operations.
The particular difficulties faced by the directors and the court were:
If the directors paid all current claims made by those with asbestos related diseases (for which there were sufficient funds both now and for the immediate future), the pool of funds available to future claimants (who were not currently identified, because they had not yet fallen ill, but were almost certain to exist in the next 40 years) would be exhausted before all possible claims were dealt with.
However, if the directors appointed a provisional liquidator, then substantial funds would be expended in the provisional liquidator coming up to speed on relevant issues, and more importantly, the payment of agreed claims would be compromised both as to timing and amount. As the court pointed out, the lifespan of someone with an asbestos related disease is generally not long after diagnosis, and this meant that many who suffered from the disease whose claims had been processed would not have the comfort before their death of knowing that their family had been provided for.
The appointment of a liquidator would have the effect of barring the very future creditors whose claims theoretically meant that the fund was insufficient. This is because future identified creditors claims could not be made in the liquidation because they were not "creditors" at the time of the liquidation (see below in relation to "who is a creditor").
Therefore even though there was a real possibility that the Foundation might be given access to further funds arising out of the negotiations between James Hardie and the unions, if the liquidation had started they may not assist the future identified claimants.
The directors were concerned that, even though they were acting honestly and trying to do their best by those likely to be affected by asbestos disease, they could be personally liable and guilty of insolvent trading (or failure to preserve the assets of the fund) if they continued to make payments while this issue was uncertain Their application to the court was in June 2004.. They were unable to obtain insurance. There was no point in appointing a receiver, since the receiver also could not get insurance.
The way forward
AICD considers that, as demonstrated in the Edwards case, where directors are acting honestly and the scope of the proposal is well defined, there is a good case for such an amendment to section 1318(2) to permit the court to authorise directors' actions prospectively. This is especially so where – as here – the directors were unable to obtain insurance. To quote Young CJ:
"154 Whilst it is important to ensure that people do not misuse the corporate veil and the principle of limited liability and trade whilst insolvent, it is also necessary to see to it that where companies are in a precarious position they are managed by people with the appropriate business expertise. One consequence of the trading whilst insolvent provisions is that such expertise is not available to companies because of the justified fear that personal liability might attach or even that there will be an attempt by a creditor to say that personal liability attached which can only be tested in an expensive set of proceedings.
155 The solution latterly suggested by Mr Jackman [counsel for one of the parties] of receivership is, with respect, just another manifestation of the way in which the Corporations Act compels companies in a precarious financial position to spend mega dollars on accountants to endeavour to salvage their position instead merely of appointing more experienced directors to the board. However, as the law at the moment does not permit a court to announce absolution in advance it will only be in rare cases that the Court can do anything about the matter.
The court has previously noted that directors stand alone among corporate administrators in their inability to seek directions in relation to future conduct (see para 28 of Edwards). The court therefore has wide experience in providing assistance of this kind.
AICD recommends that a proposal for reform of section 1318(2) should be referred to CAMAC for review and the development of a law reform proposal. AICD suggests that a proposal might encompass the following features:
The court would be given an expanded jurisdiction under section 1318(2) to give advice to directors and to authorise prospective action which might otherwise give rise to liability for negligence, breach of trust or breach of duty (including insolvent trading).
Recognising that courts are often uncomfortable with making orders which can affect the rights of people not represented before it unless they have been given an opportunity to be heard:
- an application to the court might require advertisement so that shareholders or affected creditors can object;
- the court should be empowered to appoint a "contradictor" which could assist the court in ensuring that all relevant issues are raised.
The court would need to act on a defined proposal and it would be the job of the directors to formulate it and to attest to its commercial desirability, pointing out to the court, to the extent that they are aware, the way in which the proposal might affect the interests of shareholders and creditors, as well as any personal interest they might have. The court should have a discretion to limit the implementation of any proposal to a particular time frame or dollar amount or dealings with specified persons. That should be left to the discretion of the court, but the court should be given express power to extend the timeframe or scope of a proposal for which it has previously granted an order.
3.2 Who is a "creditor"?
The Special Commission of Inquiry focussed on the uncertainty surrounding the question of who is a "creditor" of a company. This can affect the operation of a whole range of mechanisms in the Corporations Act, ranging from whether or not a company is insolvent and who can claim in a liquidation, to whose interest must be consulted in reduction of capital or scheme of arrangement – and the answer in part depends on the mechanism under consideration.
The question arises as to whether the rules for identification of "creditors" under the law should be changed – that is, should there be different rules for "long tail" liabilities? For the purpose of determining whether a company is insolvent, a contingent or prospective creditor is a "creditor" and must be taken into account when distributions of company assets are made to creditors and shareholders in a liquidation. However, people who might become creditors in the future, who are not yet identified but are of a kind that are likely to exist in the future (eg people who might fall victim to asbestosis) are not "creditors" (until they do in fact fall ill). The test for schemes of arrangement is looser.
The James Hardie case does demonstrate many aspects of this issue, but perhaps best that the flexibility inherent in leaving this question largely to judges is critical to the operation of a healthy economy. For instance, to include future creditors in determining the solvency of a company may mean that many companies which are in fact viable would have to cease business because of events which may never happen. That would not assist either current employees (who would lose their jobs) or the later identified creditors, since the James Hardie case also demonstrates the desirability of a company remaining in business to fund payments to those future creditors. AICD has a clear preference for leaving this question to judges and that the law should not be altered. Certainly before any change is contemplated, the issue should be referred to CAMAC.
3.3 Parent company liability for personal injuries You suggested that an area which the Attorney might consider for reform is whether there should be a change in the law to impose liability on parent companies for personal injuries caused by subsidiary companies?
AICD strongly opposes such a proposal because:
There is no significant experience of parent companies taking steps to deprive subsidiaries of funds to pay personal liability claims. As previously indicated, the James Hardie experience demonstrates that the community attitude on this issue makes it, as a practical matter, impossible for parent companies to avoid liability if they want to maintain a healthy business or any business at all.
It is likely to act as adisincentive to foreign investment, which is particularly important in major infrastructure and resource investment – an area in which foreign parent companies are likely to feel particularly vulnerable. The disincentive effect is likely to be magnified beyond the real significance of any likely liability, because it is likely to be viewed as the thin end of the wedge. Australia's straightforward legal system and political stability has previously enhanced its reputation as a safe place for foreign investment.
While a few states of America have adopted versions of this proposal, it is dangerous to "cherry pick" solutions of this kind. The legal system in the United States has counterbalances to these features which are not present in our system and which may not be politically acceptable to adopt. In particular, the US system has the availability of "chapter 11" bankruptcy protection and the significantly lighter liability of directors of companies for insolvent trading. If Australia were to "lift the corporate veil" in this way, it would create a very much more hostile environment for investors and officers of companies compared to the US. Additionally, Australia is a comparatively small economy (2% as opposed to the US52% of world equity markets). If we want to attract investment, our legal structures need to be clean and simple, and that may mean that we cannot afford to adopt the same sorts of solutions which might be viable in a larger economy.
The assets of a parent company can be made available to creditors of subsidiary companies through a number of existing mechanisms. These include:
- agency principles – where the subsidiary can be said to act as the agent of the parent;
- where the parent company acts as a shadow or de facto director of the subsidiary – because the directors of the subsidiary are accustomed to act in accordance with the directions or instructions of the parent;
- cases of fraud;
- liability of parent companies for insolvent trading of subsidiaries under the Corporations Act;
- voluntarily engaged in cross-guarantee arrangements as a basis for reporting relief under ASIC class order arrangements.
Some have argued that these mechanisms do not adequately serve "involuntary creditors" – such as those to whom a subsidiary may owe a liability in tort – and that making parent companies liable for torts (eg personal injury) would be a very narrow exception. However this argument is not persuasive:
- it fails to take into account the "chance" nature of tort – an accident can occur as easily with a party who is bankrupt as a rich person.
- it prefers "involuntary" creditors of one subsidiary to the security of employment of employees of other group members and investors whose pension funds may be their only support in retirement.
There are real implications for the freedom of trading of assets, which is incredibly important to economic efficiency. A few examples of the sorts of practical issues which might arise are as follows:
- which parent company has liability? Is it all holding companies where there is a chain of companies? Or just the ultimate parent?
Using asbestos as an example – is it the company which was parent at time exposure occurred (the time of exposure is often not known) or the time of at which illness manifests (why would that be fair if it was not the parent at time of exposure?)
If a holding company sells a subsidiary, does it cease to have liability? Does the new holding company acquire liability? Does the liability have to have been identified at the time the sale occurs?
- Does the rule apply only in wholly owned groups? If not, where is the fairness as between investors in the subsidiary? If yes, then there are obvious mechanisms for avoidance.
- Such a proposal is likely to encourage investors to arrange their affairs so that there are no "subsidiaries" as defined. This is bad public policy because these kind of arrangements encourage a culture of avoidance and make lines of responsibility (not only legal but day to day management) less transparent and effective.
- What liability should be imposed by a new law for past torts? Arguably none because the holding company today may not be the same as the holding company at the time of the tort and in either case, the holding company may itself have no insurance for this new liability.
3.4 Reduction of capital – should court role be reinstated? Should the Corporations Act be amended to re-impose the requirement for court approval for reductions of capital? This question arises out of the cancellation of partly paid shares by ABN 60, notwithstanding that their existence had been part of the factual matrix under which the NSW Supreme Court had approved the scheme of arrangement under which the James Hardie group was re-organised in 2001.
While it is true that if a court procedure were required the question of the role of the partly paid shares in securing court approval to the scheme of arrangement in 2001, AICD does not support re-imposing this procedural step in capital reductions. There is no evidence of any systemic failure of the regime under section 256B.
4 Conclusion
AICD recognises the harm which many people have suffered through exposure to asbestos products, and the controversy which has surrounded the James Hardie case.
Many of the issues identified above have greater emotional weight because of this context. However, balanced consideration of all of these issues is fundamental to the effective and efficient operation of our economy and they need to be treated with great caution. Some "solutions" have immediate emotional appeal, but our community (employees as well as investors) derives many benefits out of the limited liability regime to which we are now so accustomed that the benefits tend to fade into the background.
All of the issues raised required detailed, expert and disciplined consideration and AICD commends to you the CAMAC and ALRC law reform processes before any proposal is taken forward for recommendation or adoption.