Conduct up and coming AICD Review

  • Date:01 Feb 2005
  • Type:CompanyDirectorMagazine
Section 1318 of the Corporations Act allows a court wholly or partly to relieve a director of a company 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.

Conduct up and coming

Can a director seek relief from liability for future conduct? asks Bruce Cowley*

Section 1318 of the Corporations Act allows a court wholly or partly to relieve a director of a company 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(1) provides that such relief can be granted where civil proceedings have been instituted against a director while section 1318(2) allows relief to be granted when a director "apprehends" that a claim will be made against him or her for a breach of duty. The precise ambit of section 1318(2) has recently been clarified by the New South Wales Court of Appeal in Edwards & Ors v Attorney-General (NSW) & Anor (2004) 208 ALR 605.

In February 2001, James Hardie Industries (JHIL) established the Medical Research and Compensation Fund. The deed which established the fund also provided that the fund's trustee was to be the Medical Research and Compensation Foundation, a company limited by guarantee.

The main assets of the fund were shares in two former JHIL subsidiaries: Amaca and Amaba. Both of the two subsidiary companies were subject to numerous claims for asbestos-related injuries and death.

Before long, it became clear to the directors of the foundation that the assets of Amaca and Amaba would be exhausted before all outstanding asbestos claims could be dealt with.

The basic problem faced by the directors was that if current claims were paid then that would diminish the pool of funds available to future claimants while non-payment could result in the companies being liquidated.

The directors could have appointed a provisional liquidator, something they had, in fact, sought to do, but the difficulty at the time of the Edwards case was that the Special Inquiry into the affairs of JHIL and the foundation was still ongoing and the directors considered that possibility existed that recommendations of the inquiry might assist the foundation to meet its responsibilities to future claimants.

Either way, the directors perceived themselves to be at risk - at the hands of creditors for insolvent trading, or to shareholders for failing to preserve company assets. On top of this, it was also proving difficult for them to obtain D&O insurance.

This situation lead the directors to apply to the New South Wales Supreme Court in June 2004 for, among other things, an order under section 1318(2) relieving them from liability that might be incurred by having the two subsidiary companies continue to pay claims until at least December 2004. The case was removed directly into the Court of Appeal.

The court came to the conclusion that section 1318(2) could only be relied on where a director has reason to apprehend that a claim may be made against him or her for a past breach.

The court accepted that it was appropriate to make an order under the section to protect the directors from any liability incurred up until the day on which it handed down its decision. However the directors did not think it was possible to rely on the section to seek protection against any action for breach of duty that might flow from any conduct taking place after that date. Each additional payment made to a claimant by the foundation would constitute a fresh act that could not be prospectively sanctioned by the court.

The court did suggest however that where an order under section 1318(2) has been granted once for a particular kind of conduct then it would usually follow that another application made at a later time would yield an identical order.

The decision in Edwards will make it difficult for a director to obtain court approval for future conduct. Interestingly however, the decision in this case seems to be at odds with the generally accepted position that shareholders can approve future conduct of directors which would otherwise amount to a breach of duty. (See Carabelas & Anor v Scott [2003] SASC 389).

Probably the message to draw from Edwards is that, where directors consider it necessary, it is in their best interests to seek an order under section 1318 as soon as possible.

If they are unsuccessful in obtaining the order, then the course of conduct can be stopped at an early stage.

If the application succeeds, then the directors can take some comfort from the fact that, having sanctioned a particular course of conduct once, a court is likely to provide the same protection at a future time for similar conduct.

* Bruce Cowley is a partner with Minter Ellison

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