Directors Counsel

Professor Bob Baxt reviews Federal Court comments on whether directors need to bring special skills to their positions.

The skills you need

Directors of companies are, and should be, well aware of the broad obligations imposed on them in carrying out their duties The duty of care and diligence is not only a requirement of the common law (and has been for some years), but is also required by section 180(1) of the Corporations Act 2001.

An additional "ingredient" sometimes thrown into the mix in assessing the obligations of directors is whether they should be able to show they have the necessary skills, especially when serving on the boards of companies in specialised industries. A recent decision by Justice Moore of the Australian Federal Court, Entirity Business Services Pty Ltd v Garsoft Pty Ltd [2011] FCA 76, provides some comfort to directors in regard to this "obligation".

The case involved a proprietary company, Entirity Business Services, and concerned a dispute flowing from the dissolution of a joint venture between two parties involved in the business. It had provided computers and information technology.

For our purposes, it is unnecessary to delve into the dispute or the details following the dissolution of the joint venture and in the litigation that was pursued. It is sufficient to note that as a result of the dispute and the concerns as to how the relevant business had been managed, Entirity brought proceedings against Anthony Garrard – a former director and shareholder of Entirity – and companies in which he was a director and shareholder. Barlow, who was the co-venturer with Garrard, joined in the action against Garrard and his company Garsoft.

Two major claims were made in the Entirity case. First, it was alleged that Garrard and his companies had engaged in misleading or deceptive conduct in relation to the type of work that would be undertaken and the service that would be provided in relation to the joint venture. The applicants also sued Garrard for breaches of his duty as a company director under section 180(1) of the Corporations Act. The actions were defended vigorously on all scores.

The directors’ duty claims brought by Entirity in broad terms were that Garrard did not exercise the appropriate care and diligence in setting up the system of accounts that were relevant in running the company, did not know how the system operated, did not ensure the staff knew how the system operated and did not check on the operations on a regular basis to ensure no mistakes were made.

It also alleged that he had refused to accept advice relating to the system in operation, which meant that the problems faced were exacerbated.

Again, it is unnecessary to detail the facts to ascertain whether these allegations were justifiable or not. Suffice it to say that the claim against Garrard failed pursuant to the section 180 claim. In the context of that decision, Justice Moore made a number of interesting and useful observations on the duties of a director to exercise relevant skill, which it was alleged he had failed to display.

He commenced his judgement by reviewing the basic principles of law relevant in a case of this kind. While the thrust of these principles are probably well known to readers, I set out relevant paragraphs as it is often useful to assess a decision against the summary of the law that the judge is considering: At paragraph 58, Justice Moore noted:

• "Directors owe a duty of care and skill at common law and in equity: Daniels t/as Deloitte Haskins & Sells v AWA Ltd (1995) 37 NSWLR 438. However, the equitable duty to exercise reasonable care and skill is not properly classified as a fiduciary duty.
• The statutory duty of care and diligence embodied in section 180 is essentially the same as the duties of directors under the common law.
• In determining whether a director has exercised reasonable care and diligence, the question to be asked is what an ordinary person, with the knowledge and experience of the director, might be expected to have done in the circumstances if acting on their own behalf.
• In determining whether a director has breached the statutory standard of care and diligence, the company’s circumstances and the director’s position and responsibilities within the company must be considered.
• Directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company.
• A director appointed because of special expertise is not relieved of the duty to pay attention to matters outside that area of expertise.
• Where there is a transaction involving the potential for conflict between interest and duty, the duty of care and diligence must be exercised with special vigilance."

The question of what skill might have to be brought by a director to his or her position as director has been considered from time to time. The New South Wales Court of Appeal in the Deputy Commissioner of Taxation v Clark [2003] 45 ACSR 332 noted that there was no reference to skill in the statutory duty under the predecessor to section 180; the position remains the same now.

In the court’s view, this meant that "conduct [is] ordinarily measured by reference to what the reasonable man of ordinary prudence would do in the circumstances" (45 ACSR at [667] – [668]).

Justices Clarke and Sheller also noted: "Skill is that special competence which is not part of the ordinary equipment of the reasonable man but the result of aptitude developed by special training and experience which requires those who undertake work calling for special skill not only to exercise reasonable care but measure up to the standard of proficiency that can be expected from persons undertaking such work... A director may be appointed because of a particular or special skill and may take up the appointment on the basis that he or she will bring that skill to the performance of the office" (45 ASCR at [667] – [668]).

A similar issue arose before Justice Austin in ASIC v Vines [2003] 48 ACSR 322. In Vines, the relevant director’s position was that of CFO. It was accepted by the judge that this was a position in a large corporation where special skills might be relevant. Vines had been appointed because of a special skill that he enjoyed.

Justice Austin added: "The degree of care and diligence expected is that encompassing the special skill that is brought to that office and the degree of care and diligence that a reasonable person with similar responsibilities would exercise" (at [60]). Justice Austin ruled that the appropriate skills had not been established. His findings were upheld by the New South Wales Court of Appeal in Vines v ASIC [2007] NSWCA 75, in which Chief Justice Spigelman and Justices Santow and Ipp noted: "It is quite clear that it was the intention of Parliament to adopt an objective standard, so that the earlier debate about whether or not directors could be excused by reason of their own particular lack of relevant experience or skill was resolved" (at [129]).

In the Entirity case, Justice Moore observed that consideration of the issues had been updated by the New South Wales Court of Appeal in the James Hardie litigation (Morley & Ors v Australian Securities and Investments Commission [2010] NSWCA 331).

In that decision, the court noted (by way of obiter dicta): "The postulated reasonable person in section 180(1) embraces any special skill or expertise the director or officer possesses, and the non-executive directors were expected to bring their knowledge and experience to the performance of their duties" (at [817]).

The New South Wales Court of Appeal embraced the statements made by their brother judges in Vines.

After reviewing the facts in the Entirity case, Justice Moore concluded: "Garrard did not become a director of Entirity because he possessed some special skills concerning the maintenance of accounts and bookkeeping. His appointment was a consequence of the decision he and Barlow made to collaborate in the joint venture and to carry on business through a company they jointly owned and were to operate. It is true he had, on behalf of Garsoft, accepted responsibility for maintaining the accounts. However, this does not clothe him with expertise of the type which would render him liable as a director. There is a material difference, in my opinion, between a person assuming a contractual (either on their own behalf or on behalf of a company used by that person to carry on business) responsibility for implementing and maintaining a system of accounts and assuming, as a director with no particular expertise, a duty to either maintain or monitor the accounts, a breach of which would involve contravention of section 180" (at [62]).

He noted that there was no breach of duty.

His Honour also found against Entirity in its claim based on the allegations relating to misleading or deceptive conduct, but accepted a cross claim by Garsoft in relation to issues arising out of work undertaken.

He noted: "The costs of this litigation are almost certainly utterly disproportionate to its subject matter" (at [80]).