Directors’ duties and penalties – further fallout from the Vines case

Professor Bob Baxt provides an overview of recent court decisions affecting the role and responsibility of directors. Many of the matters examined in the Law Reporter are discussed in greater detail in The Baxt Report published by Thomson Publishing.

In last month’sLaw Reporter, we dealt at some length with the NSW Court of Appeal decision on whether Vines had breached certain duties as an executive officer of the GIO Corporation (Vines v Australian Securities and Investments Commission [2007] NSWCA 75 (CD: June 2007, p49). The New South Wales Court of Appeal, while upholding some of the rulings by Austin J at first instance and ruling that Vines had breached provisions of the Corporations Law, overturned other findings. In doing so, the court provided some clarification of the threshold issues that needed to be addressed in evaluating the duties of a senior corporate officer.

Now, in the follow-up Court of Appeal decision, the same court has reviewed the penalties imposed by Austin J on Vines (Vines v ASIC [2007] NSWCA 126). Once again, the Court of Appeal, comprising Spigelman CJ, Santow JA and Ipp JJA, has overturned parts of the judgment of Austin J in the penalty hearing (see Australian and Securities Investments Commission v Vines [2006] NSWSC 760; 58 ACSR 298), which we noted in the October 2006 issue of Company Director. In that penalty hearing, Austin J had made orders pursuant to the relevant provisions of the Corporations Law (now Corporations Act) which consisted of a fine of $100,000. He also disqualified Vines from managing any corporation for three years.

In a unanimous decision on this occasion, the Court of Appeal ruled that Austin J was incorrect in disqualifying Vines for three years and, by doing so, ruling that Vines was not a fit and proper person to manage a company for that particular period of time.

Austin J at first instance

It is useful before turning to the Court of Appeal decision to remind ourselves of what Austin J had regarded as critical in assessing whether Vines was a fit and proper person. He stated that he was required, in evaluating that question under s 1317EA(4) of the Corporations Law, to consider whether:

“…despite the contravention, the defendant was a ‘fit and proper person to manage a corporation’, and the court is not to make a disqualification order if it is ‘satisfied’ that the defendant is fit for that purpose… The application of the statutory language is difficult, because of the very wide range of activities conducted in corporate forms. The corporation may be a private shelf company, a private investment company, a corner grocery business, a charitable body, a cash box, a mining explorer without any present business revenue, an established middle sized manufacturing business, a parent entity in massive international businesses, and so on, to infinite possibilities. Which of these kinds of activities are encompassed by the expression ‘manage a corporation’?”

Austin J answered his own question by ruling that the relevant provision required him to deal with the issue in the context of management of corporations generally, not the particular corporation in which the offence had occurred, nor any particular subgroup of corporate activities. Austin J was satisfied that Vines had demonstrated a deficiency or inadequacy in respect of the particular corporation. This, in his discretion, could be a sufficient reason to disqualify him. In this case, of course, we are dealing with a publicly listed company and Austin J formed the view that the ‘discretionary’ threshold had been established by the facts. He reached this conclusion notwithstanding the important and fairly large number of character witnesses who came forward in support of Vines. Disqualification for a limited period of time was appropriate, in his view, which he reached by balancing a number of matters in his assessment of all the facts concluding that Vines was not a fit and proper person to manage a corporation.

Managing a corporation – on appeal

That assessment was rejected by the unanimous Court of Appeal.

It is interesting in evaluating the question of whether Vines was a fit and proper person to see how Spigelman CJ disagreed with the evaluation of Austin J. Section 91A of the Corporations Law (as it then was) provided, relevantly, that when deciding when a person “was a fit and proper person to manage a corporation” one looked at the definition of the word “management”, which was extended to covering activities which were those “in any way (whether directly or indirectly) concerned in, or taking part in, the management of a corporation”. That is an extraordinarily broad definition which is relevant in assessing the nature of the penalty that might be imposed. Spigelman CJ felt that the evidence from senior officials who worked with Vines allowed him to reach a different conclusion. The other judges agreed with his conclusions.

Pecuniary penalty

While Santow JA disagreed with the final penalty decision given by Spigelman CJ and Ipp JA, it is worth reviewing the language he used at paragraphs 202 to 203.

Turning to the judgments of Spigelman JA and Ipp JA, it should be noted that they also felt that the penalties were too harsh. They recognised that, in the absence of dishonesty and so on, a lesser penalty might be relevant, although they disagreed with the view of Santow JA that there was nothing really serious involved in the particular conduct. Vines’ conduct did involve an error of judgement or inadvertence had to be assessed which, in the words of Ipp JA in the context of “considering the degree to which the appellant failed to exercise care and diligence, regard must be had to the crucial leadership decision he held in the due diligence process, [the takeover documents] and the profit forecast” (at para 248).

Ipp JA agreed with the thrust of the views expressed by Spigelman JA. As noted earlier, Santow JA disagreed with the majority. In his view, the nature of the penalty should reflect whether proper concern had been expressed by the defendant for any adverse consequences of the risk that was associated with the failure to act with appropriate care.

He concluded his decision by holding that Vines could rely on others in the organisation in signing off on the relevant document, that the consequences of the errors were not as serious as envisaged by the operation of this penalty regime and the statute, and stated that:

“Where there is no dishonesty or impropriety and each breach was essentially the product of honest error of judgment not lack of application, then judging seriousness objectively and according to community standards, one should not characterise the contraventions here, singly or collectively as serious …” (at para 194)

Because of the fact that the court once again was divided on one of the critical issues, it may well be that the question of magnitude of penalties may be appealed. However, as Vines was able to succeed on the critical question of whether he should be disqualified from managing a corporation, the reduction in the monetary penalty may not be regarded as sufficient to warrant an application for appeal.

The Gambotto Case again – inappropriate dealing with minority shareholders disapproved of by the court

The High Court decision in the landmark case of Gambotto and Anor v WCP Limited and Anor (1995) 13 ACLC 342 – in which the court ruled that the amendment of the articles of association of a company which led, in effect, to the “confiscation” of the shares of a minority shareholder following a takeover amounted to unfair or oppressive conduct – was regarded by many as uncommercial. As a result, the Corporations Act was amended to make it easier for companies to compulsorily acquire a certain percentage of minority shareholdings in the company outstanding following a takeover.

However, where shares are purchased by a company or, in effect, a majority shareholder as a result of forfeiture of the shares triggered by a change in the articles of association (or the constitution, as it is now known as) the principles laid down by the High Court in Gambotto may still apply according to an interesting judgment in the Supreme Court of Queensland (Bundaberg Sugar Limited & Anor v Isis Central Sugar Mill Company Limited [2006] QSC 358; 24 ACLC 1550).

In essence, the facts of that case were briefly these (as taken from the CCH headnote). Isis Central Sugar Mill Company produced sugar. It had 450 members, which were sugar growers, either in person or corporate capacities, and each owned shares. One of these members was a company called Branchvale, which held nearly 16,500 shares in Isis. Bundaberg Sugar (Bundaberg), an unlisted public company with several businesses connected with the sugar industry, wanted to become a shareholder in Isis. For a number of years, Bundaberg had supplied sugar to Isis. But once the sugar industry was deregulated in 2005, Isis refused to accept sugar cane from Bundaberg. It also refused to enter into contracts with it.

In the interim, Bundaberg had agreed with Branchvale that it would buy Branchvale’s shares in Isis. Bundaberg refused to register the transfer shares in Isis and this decision was challenged in a separate case. Instead, the directors of Isis argued that Branchvale had “forfeited” shares in Isis in 2003 as a result of the operation of a clause which had been included in the articles of association. Isis argued that the forfeiture had occurred when Branchvale had, in fact, breached Article 5 when it had ceased to be a supplier of sugar cane to Isis. At that time, it was required to comply with a notice given to it under the terms of the articles of association either to transfer its shares or to once again become a sugar supplier. The forfeiture of the shares was disputed. Both Bundaberg and Branchvale asked the directors of Isis to register the relevant share transfer.

In the relevant action in the Supreme Court of Queensland, Bundaberg and Branchvale argued that Branchvale’s shares in Isis could not be forfeited except if there was a non-payment of a call on the shares. Any article which permitted the forfeiture of the shares would be invalid in other circumstances. This was because the company would, by purchasing its own shares (in itself), commit a breach of a fundamental principle of law. It was argued that the amendment made to the articles of association in 1987 to introduce such a clause was invalid because it was against the principles enunciated in the Gambotto case referred to earlier.

Chesterman J, the judge in this case, canvassed many interesting decisions in reaching his conclusion and, in particular, revisited the High Court decision in Gambotto. He ruled that, in effect, the amendment of the articles of association was not possible by including a clause allowing forfeiture of the shares in these circumstances. The relevant member (in this case Branchvale) in this situation of ‘forfeiture’ “lost all ordinary rights and entitlements. Its name was removed from the register of members and it [might] not receive dividends, or attend or vote at general meetings or participate in the proceeds of a voluntary winding up” (at para 71). Chesterman J agreed with Bundaberg. See in particular his comments at paras 81 and 82.

Chesterman J noted that the fact that forfeiture preceded the transfer of the shares to another shareholder did not mean that the Gambotto case did not apply. In his view, the power to alter the articles would only be exercised properly if the resolution by which they were amended “was passed for a proper purpose and the article would not operate oppressively in relation to the members whose shares are forfeited. The power of amendment will have been exercised for a proper purpose if the company reasonably apprehended that the continued shareholding of the minority – that is, those members who cease to be suppliers of sugar, would be detrimental to the interests of the other shareholders generally” (at para 84).

In his view, the defendant had failed to establish that Branchvale’s continued membership was detrimental to the company. He held that amendment to the article was invalid as it was not possible for the shares to be forfeited in this way.