The role and duties of company officers Law Reporter

When Justice Neville Owen was completing his report into the collapse of the HIH insurance company one of the critical questions he faced was whether the Corporations Act and the general law relating to the activities of company directors and officers should be revisited to place a greater burden of responsibility on company officers rather than on directors.

This question has continued to pose problems for the business community, their advisers and government policy makers

The role and duties of company officers

Shareholders have been told very little - indeed not enough - about the rights of a company to pursue directors over their breaches of duty

When Justice Neville Owen was completing his report into the collapse of the HIH insurance company one of the critical questions he faced was whether the Corporations Act and the general law relating to the activities of company directors and officers should be revisited to place a greater burden of responsibility on company officers rather than on directors. This question has continued to pose problems for the business community, their advisers and government policy makers

When the Harmer Report in the early 1990s (on behalf of the Australian Law Reform Commission) led

to a significant revision of the insolvent trading provisions of the Corporations Law (as it then was) to shift responsibility for insolvent trading from company officers to company directors for contraventions of the law a significant "sigh of relief" was heard from many members of the business community. But, in recent times, with many corporate collapses occurring in circumstances in which directors have been criticised for not overseeing with sufficient detail the activities of company officers, there has been a call for a revision of the law.

Justice Owen in his report into the HIH collapse certainly highlighted the need for this matter to be revisited. The Corporations and Markets Advisory Committee (CAMAC) is currently faced with the task of not only revisiting the duties of directors as a whole, but also the position of officers in light of the HIH Report.

A recent decision of the New South Wales Court of Appeal has once again focussed our attention on this matter in the context of the existing law. This was the case of Forge & Ors v Australian Securities and Investments Commission ((2004) 52 ACSR 1) which also raises very interesting issues concerning the ability of directors to escape liability by the ratification of their actions.

This was an appeal brought by the appellant Forge, and a number of other directors of certain companies involved with CTC Resources NL. ASIC had alleged that a number of transactions entered into between April and November of 1998 for and on behalf of CTC were uncommercial. ASIC also alleged that certain officers and directors of CTC were in breach of specific provisions of the Corporations Law (which will not be discussed in the body of this note).

ASIC succeeded in obtaining a number of declarations against them from Justice Foster. Some of the matters on appeal related to constitutional arguments concerning the operations of the Corporations Law and the Corporations Act and the interpretation of various provisions of the Corporations Act in relation to technical issues.

It is appropriate to set out the facts of this case in some detail to appreciate the issues considered by the trial judge and by the Court of Appeal. These facts are taken from the Butterworths Law Reports:

1. The first defendant William Forge was a friend of Endresz family and the sole director of a company Bisaya Pty Ltd (B) (Forge's family private company).

2. The second, third, fourth and fifth defendants were all members of the Endresz family, and were involved in the family company Kamanga Pty Ltd (Kamanga) .

3. The Endreszs were at different times directors of the principal company involved in this case – CTC. That company had been listed on the Australian Stock Exchange for some time. At the time of the relevant action by ASIC it had been delisted. Later another member of the Endresz family was appointed a director of Forge and became a director on 9 September 1994.

4. In 1992 a fixed and floating charge of $1 million was registered over all the assets of CTC in favour of Kamanga.

5. CTC had about 1200 shareholders but no meetings of the company had been held between 1991 and 1997. On 23 March 1998 an annual general meeting was held in respect of those years. Accounts were produced and approved by the shareholders. Those accounts indicated significant losses. A deficiency of well over $1.4 million was disclosed in 1997. In April 1998 CTC received $6 million from the Commonwealth of Australia and in return had issued redeemable non-participating A class preference shares. Following receipt of that money certain payments were made to Kamanga, and Mr Forge's family company B.

6. ASIC complained that a number of these transactions involved contraventions of a number of provisions in the Corporations Law and the Corporations Act including the related party transactions (payments made by companies to persons who had an interest in the company) as well as breaches of statutory duties of the directors who it alleged had acted recklessly in pursuit of their duties. ASIC also sued Forge in his capacity as an officer of the company.

7. In 2003 CTC purported to hold meetings of shareholders in which it sought to ratify relevant transactions including the relevant loan and payments.

8. CTC had also instructed certain consultants to sue the ASX for improperly delisting the company shares but this action had failed

9. The auditors of CTC had expressed concerns about the solvency of the company since 1990. All of its accounts from 1990 to 1996 had been qualified. The company had made no worthwhile profits in any of the relevant financial years the subject of the transactions.

One of the critical questions was whether Forge who had not been acting strictly as a director of the company but who was involved in carrying on certain important activities on behalf of the company, was an officer of the company "concerned in the relevant transactions", thus raising the potential for liability under specific provision of the legislation.

A central question for the trial court and for the Court of Appeal on this allegation was whether Forge (and associated persons), had been involved in the transactions for the purposes of the specific provisions of the Corporations Act (and the Law). (Section 79 of the Corporations Act applies to persons are involved in particular transactions). Alternatively did he (and other officers) have actual knowledge of the "essential material factual ingredients of the relevant contraventions".

The critical evidence which ASIC relied on in pursuing this question was that Forge had "effectively counselled and procured the transactions which led to the approval of [the payment of the moneys which were the subject of the ASIC prosecutions]" (see para 175). The trial judge had as a matter of law found that Forge (and others) was involved in the contraventions concerned and that, as such, liability should be held to apply to Forge (and those others).

At the time the Corporations Law contained a definition of an officer which depended on whether the person had "been concerned in or took part in the management" of the company.

The New South Wales Court of Appeal, through Justice McColl JA who delivered the major judgment, reviewed earlier cases which had interpreted this expression. He concluded that the relevant person had been concerned in the particular activities and that he had "been involved" in relation to the contravention.

The Court of Appeal affirmed the approach taken by Santow J in ASIC v Adler ((2002 NSWSC17) where he held that "knowledge may be inferred from the fact of exposure to the obvious although that did not obviate the need for actual knowledge of the essential facts constituting the contravention". (para 202) Reviewing all of the evidence and the appropriate law the Court of Appeal held that the trial judge's finding that the law had been breached was justified.

The defendants, however, also argued, not only in the context of their position as officers, but also in the context of their position as directors (where breaches of the legislation had also been confirmed by the trial judge), that they should be excused from liability on two grounds.

In the first place they argued that they had acted in accordance with the articles of association of CTC in carrying out the transactions. The reliance by the relevant appellants on the company's articles of association, while it did provide an argument that they had a degree of flexibility in how they interpreted the financial issues under consideration by the company did not go so far as to provide the appellants with an argument that their fiduciary duties owed to the company were somehow watered down. Recognising that constraints imposed on a director in dealing with a person to whom "fiduciary duties are owed may be ameliorated to some extent in so far as a director and the director's company are concerned by the memorandum and articles of association of the company" ... McColl JA noted that "such [an] article cannot relieve a director from the obligation to act in the best interests of the company as a whole ..." (para 238)

In the court's view the articles, when properly interpreted, did not in any way relieve the directors of their primary obligation which, in the context of the financial position that the company faced was a rather precarious position that they faced.

The suggestion that the shareholders of the company had ratified the actions of the relevant directors was a bold one at worst and a quite extraordinary one at best. McColl JA dealt at some length with a number of cases in which the question of whether ratification could be affected in situations where the directors were seeking "forgiveness" or ratification of breaches of statutory duties as well as common law duties, is a matter that is currently before the High Court in Carabelas (see Carabelas and anor v Scott (2004) 22 ACLC, Law Reporter, September 2004).

The appellants put the matter in this way:

"Members of a solvent company have wide freedom to take honest but stupid business risks in authorising or ratifying acts of directors, provided the acts are not fraudulent ... (they referred to a number of cases to support that proposition)."

The appellants further submitted that the evidence demonstrated that the company "was solvent when the ratification resolutions were passed. They said they accounts showed that all current liabilities had been paid." (paras 355-356)

The NSW Court of Appeal reviewed the evidence put forward by the appellants as well as by ASIC and found in favour of the interpretation of the facts by the trial judge in support of ASIC.

McColl JA answered the question of whether ratification did operate to relieve the directors of their common law duties in these words:

"In my view the ratification resolutions were ineffective because they sought to cure the appellants' wrongful taking [of the company's] resources. Further, the shareholders did not exercise their voting power for the benefit of the company as a whole in the sense referred to [in the cases]." (para 376)

Insofar as the ability of the shareholders to ratify a breach of statutory duty the New South Wales Court of Appeal reviewed many of the cases we have discussed in previous notes dealing with the Carabelas case.

The Court of Appeal ruled that when one took into account the conclusion of the primary judge that:

"each of the appellants had failed to act honestly in relation to the transactions, the court could not have relieved them from their liability for the contraventions pursuant to the [Corporations Act]. ...

"I would conclude that even if the shareholders could, contrary to what I have already [held] ratify the private law breaches of the directors' duties, the ratification resolutions were ineffective to cure the breaches of statutory duty." (paras 383-384)

Another reason why the ratification failed was that the alleged ratification had taken place much later than when the particular actions were taken. The decisions were made far too late in the timing of the relevant transactions.

Disclosure and ratification

Finally, any ratification resolution to be considered by the shareholders must be one supported by full disclosure of the particular issues that have to be considered.

In the Court of Appeal's view the materials that had been placed before the shareholders of CTC at the relevant meetings at which the resolutions were taken did not adequately refer to the rights that the company had against the directors for the various activities that had been involved. The shareholders had been told very little, indeed not enough about the rights of the company to pursue the directors for their breaches of duty. In the view of the Court of Appeal the omission of this information was "egregious".

The judge concluded:

"In my opinion it was necessary for the ratification to be effective that the shareholders be fully informed of the [company's rights] consequent upon the declarations of contravention and that the effect of the ratification resolutions could be that [the company] would lose both its statutory and equitable rights. The shareholders were never given that information. Accordingly, in my view, the disclosure to the [company's] extraordinary general meeting was inadequate. The ratification resolutions could not waive the consequences of the contraventions and were, therefore, ineffective." (para 402)

In all of the circumstances the attempts at ratifications failed as with the arguments with the appellants.

This question will no doubt be considered further in the High Court of Australia in Carabelas later this year.

Director's liability insurance at the crossroads

Insurance companies may rephrase the language of contracts so as to deny the advancement of legal costs

Two decisions in the High Court of Australia on the same day, 7 April 2005, Silbermann & Anor CGU Insurance Ltd ([2005] HCA 16) and Wilkie v Gordian Runoff Ltd ([2005] HCA 17) have left company directors, seeking advances on their liability insurance policies to ensure that they were adequately "funded" to fight claims brought against them for breaches of directors' duties, in a state of some legal uncertainty.

One way of assessing the cases is to suggest that Silbermann's case was doomed to failure because of the way in which the appeal was argued (they may have another opportunity to seek a recovery of legal costs once the ASIC litigation is completed) and that the Wilkie case gives us some more positive insights into the law.

The critical questions, from the perspective of company directors, is that provided the relevant insurance policy is drawn up in a way which gives the insured (the director) the opportunity to have his or her case tested by a third party - a court, an arbitrator or someone in a similar capacity - before a final decision is reached in relation to the claim for indemnity (in this case costs), then these types of insurance policies will be of great value.

The Silbermann case has already been noted in Law Reporter (November, 2003). In effect the appellants in this case (Silbermann and Rich) sought indemnity for an advance payment of costs to defend proceedings brought by ASIC against them. The CGU argued that it was not obliged to provide any advance because it was entitled to avoid the policy under the terms of the exclusion clause of the policy and the Insurance Contracts Act. The exclusion clause operated because of alleged dishonest and fraudulent conduct on the part of Silbermann and Rich.

The New South Wales Court of Appeal had upheld the arguments of CGU but the High Court granted special leave to Rich and Silbermann to have the matter adjudicated at that level.

When the case was argued in the High Court, however, Silbermann and Rich chose to limit their application to the question of whether they were entitled to advance on costs but did not challenge the findings of the lower courts that the insurance company CGU was entitled to rely on the exclusion clause.

Silbermann and Rich argued that CGU could not in fact rely on the exclusion clause until there had been a final adjudication on the ASIC action against them. As in most insurance contracts of this kind if the insured person is found guilty of relevant dishonest conduct etc, the insurance company is not obliged to pay.

Three separate judgments were delivered in this case. Gleeson CJ, McHugh and Gummow JJ, held that as the appellants did not question the assertion by CGU that it was entitled to exclude liability, it was not possible for the appellants to assert that they could have their question decided upon by the court in one proceeding with the other questions (the validity of the denial of the claim) being determined at a separate proceeding.

"The principles respecting avoidance of circuity of action indicate that the litigation would not be resolved by orders obliging CGU to make payments it was not and never had been required by contract to make" (para 20) - in other words it would be pointless if having won the argument of advance of the relevant payments CGU could then have a further judgment delivered saying that the advances should never had been paid.

Had all the matters been argued together the court would have at least be in a position to resolve the issue in the same way as it resolved the issue in the Wilkie case.

Both Justices Kirby and Callinan, in separate judgments, while they reached the same result - that is that the appeal should not be allowed to proceed - ruled that the commercial purpose of the policy and the exclusion clause itself, required ambiguities to be decided in favour of the appellants. CGU could not therefore bring itself within the exclusion clause that nothing had been established by final adjudication on whether the appellants were guilty (see para 68).

Callinan J was unable to agree with CGU that it was not required to advance defence cost in this case. He pointed to the difficulty in drawing the line within disqualifying and other conduct, and the fact that allegations of dishonesty could and would be made "in cases of the kind in prospect against the appellants" (para 69).

He noted that just because there was corporate failure this was an insufficient basis for an allegation of dishonest conduct in cases of this kind. He also agreed that in denying directors and officers the means of defending themselves, or doing so adequately, against actions that were likely to be brought as a result of corporate collapse, would deny these directors the ability to refute allegations that would lead to them being disqualified to claim under the insurance policy.

This was also the thrust of the general argument that Callinan J advanced in the Wilkie case.

This appeal concerned the construction of an insurance policy which was taken out to ensure relevant directors and employees of FAI Insurance and its subsidiaries against losses arising out of certain claims.

Wilkie was in the class of persons covered by the terms of the policy. The question for construction of the policy arose in circumstances where Wilkie notified a claim as a result of criminal proceedings brought against him by the ASIC alleging that he, being an officer of a company within the FAI insurance group, provided misleading information to auditors of the company. It was also alleged that he had failed to act honestly in exercising his powers and in the discharge of his duties in his capacity as an officer of the subsidiary company. Wilkie denied those charges and as yet there has been no adjudication of the claims.

Wilkie's claim for indemnity was not brought on the primary operation of the policy. Rather the claim was that the defence costs that were incurred by his defence of the charges brought against him should be met by the insurance company.

FAI, after reviewing the relevant evidence which had been provided to it by the Director of Public Prosecutions (which was pursuing the case on behalf of ASIC), wrote to the solicitors for Wilkie advising them that Wilkie would be denied indemnity for the claim.

The Supreme Court of New South Wales in considering the matter ruled against Wilkie because it felt bound by the decision of the New South Wales Court of Appeal in Silbermann & Anor v CGU Insurance Ltd. In that case the New South Wales Court of Appeal had denied the claim by Silbermann and Rich for advance of moneys to pay legal costs etc in relation to the defence of claims brought by ASIC and the relevant prosecutor.

The High Court in a unanimous decision held that Wilkie was entitled to be advanced the relevant costs. Two separate (and short) judgments were written in the High Court of Australia. There was a joint judgment of Gleeson CJ, McHugh, Gummow and Kirby JJ and a separate judgment by Callinan J.

The lengthier judgment of the Chief Justice and his colleagues, turned very much on a word-by-word examination of the language of the insurance policy and the way in which the exclusion clauses operated.

On their interpretation of the particular policy the members of the High Court, ruled that Wilkie was entitled to seek an advance of the defence costs.

The judges recognised that the typical exclusion clause which would leave open to an insurance company the right to deny liability, depended on the determination (that is the final conclusion) of the claims brought against the insured (i.e. Wilkie) by a court. In this case, as the court noted, Wilkie had not admitted the charges brought against him.

The question has not been considered by a court or an arbitrator, and had not been the subject of determination by an independent decision maker (sometimes insurance contracts will allow decisions to be taken by a QC to determine how the insurance policy should be interpreted).

Wilkie agreed that any adjudication upon the merits of the case might well deny him any liability - if he was found guilty. But as the High Court noted,

"this is not the present case. This arises where advance payment is sought, upon the very hypothesis that the ultimate outcome of the prosecution of the prosecution of the appellant is uncertain" (para 38).

The insurance policy contained a right for the insurance company to seek recovery against the insured should it turn out that the moneys were advanced inappropriately - that is the insured was found guilty. The High Court recognised that that reservation of rights "may not always be a right of great value". However, the court also noted that the construction of the insurance policy that was being claimed by the insurance company was not one that the court could support on the facts. In the view of the court the exclusion clauses did not operate.

The majority judges also expressed some reservations about the approach taken by the insurance company in denying the claim. It noted that Wilkie had sought to rely on US cases to suggest that in such contracts where there was doubt the contracts should always be construed favourably in the case of an insured person. The court refused to follow the US cases suggesting that they were not necessarily on all fours with the Australian law.

What the majority judges did say, which may well be helpful in another case, was that the commercial purpose of such policies should be supported because they do afford assistance with defence costs when an insured is faced by allegations of wrongdoing including criminal wrongdoing.

The judgment of Justice Callinan, is even more encouraging in terms of the resolution of future claims in a matter of this kind.

In recognising that the majority judges had decided the case on the basis of the interpretation of the contract Callinan J made other "helpful" remarks. In his view the interpretation supported by the insurance company would lead to "a real and practical sense that the [insurance company] would become the final arbiters of the extent of their obligations because their insureds will frequently lack the means to defend themselves adequately against the charges leveled against them unless they are put in funds to do so. It would not have been a difficult matter for the [insurance company] to have insisted upon a policy that put beyond doubt their right to postpone payment of defence costs until the outcome is known had they so wished" (para 52).

This message is one that no doubt insurance companies will also take note of - they may rephrase the language of their contracts so as to deny the advancement of legal costs until there had been an adjudication of the matter.

This would place an intolerable burden on directors who would have to first fight the charges brought against them and then seek a recovery from the insurance company.

On the other hand, the insurance companies will argue that they should not have to be put to the task of having to chase a person for moneys advanced to him or her when they have been found guilty as alleged by the prosecution.

These two cases suggest that we may see a generally more helpful interpretation of clauses of this kind the future.

Perhaps the last word should be left with Justice Callinan in the Silbermann case. In paragraph 59 of his decision he made these rather interesting remarks about the way in which insurance policies should be interpreted:

"Matters relevant to the proper approach to the construction of the policy are these: that the [insurance company] is the profferer of the policy, that it is a policy designed to operate in the commercial environment of directors' (and other officers') obligations, in the ascertainment of an uncertain dividing line between dishonesty, and gross negligence, or imprudence to which Hodgkins JA [in the New South Wales Court of Appeal in that case] referred; and that the [particular clause under discussion] is an exclusion clause. These matters require that ambiguities in the construction of the exclusion clause, indeed in other parts also of the [insurance company's policy] be resolved in favour of the [insured]. That is not to go as far as a body of North American authority holds in relation to a right but ... far from identical form of policy, that any ambiguity must be construed strictly against the insurer, and, of more importance, in such a way as to prefer the insured if the policy 'contains contradictory provisions, or has been so framed as to leave room for [a] construction, rendering it doubtful [what] the parties intended' (this is known as the contra proferentum rule)."

The CAMAC inquiry into directors' duties

Changes in the wake of the James Hardie affair

While there is to be a review of the laws in relation to insolvency, as one of the compromises reached as a result of the James Hardie Report, there is still to be a re-assessment of directors duties. It is interesting to set out in some detail the "terms of reference" of Parliamentary Secretary to the Treasurer Chris Pearce to the Companies and Markets Advisory Committee (CAMAC) in relation to this broader question of the duties of directors.

The critical questions Pearce has asked CAMAC to consider, and which may well lead to a significant change in the way our Corporations Act will be framed and/or interpreted in the future are:

1. Should the Corporations Act be revised to clarify the extent to which directors may take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?

2. Should the Corporations Act be revised to require directors to take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?

3. Should Australian companies be encouraged to adopt socially and environmentally responsible business practices and if so, how?

4. Should the Corporations Act require certain types of companies to report on the social and environmental impact of their activities?

In setting out these questions, he made the trite observation that legislation other than the Corporations Act already imposes a significant range of duties on companies and their directors in relation to employees and the environment.

"For example," he said, "companies must pay their employees at least minimum rates of pay and they must comply with occupational health and safety, anti-discrimination and equal opportunity requirements. Companies must also comply with a wide range of environmental requirements."

The Parliamentary Secretary did not go on to note that companies also have to comply with trade practices laws, taxation laws, and a range of other statutes which impose obligations not only on the companies but on individuals who if they fail to act properly in relation to those laws may include personal liability.

It is interesting that the questions put to CAMAC are posed in the same way as the reforms proposed for the United Kingdom recently announced: Is it possible for directors to take into account the interests of particular persons or to adopt activities which may be more socially acceptable?

CAMAC should also be asked to clarify to what extent directors will be liable for breaches of duty if they do in fact take a course of action which may result in the company preferring the interests of, for example, employees, or the environment, to the interests of shareholders?

Will they run the risk of being in breach of their duties? This was the critical question facing the NSW Court of Appeal in Edwards case (the decision concerning the ability of directors of the James Hardie company to make payments even though they were not legally obliged to do so).

There is no reason why directors cannot take these interests into account if they balance the rights of shareholders with the good work that the company may wish to do on behalf of the community.

We will await with a great deal of interest not only for the first of the discussion papers to be published by CAMAC but of course also the work being undertaken in relation to insolvency.

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The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.