Much ado about nothing?

Professor Bob Baxt is disappointed that the discretion offered by some sections of the Corporations Act were not used when imposing penalties on former Centro executives.

A considerable amount of cynicism, and indeed some disbelief, has been expressed at the penalty decision handed down by Justice Middleton on 31 August in Australian Securities and Investments Commission v Healey (No. 2) [2011] FC 10 (the Healey case). After earlier ruling that all of the relevant directors and officers of the Centro organisations had contravened various provisions of the Corporations Act 2001 (see Directors Counsel, Company Director, August 2011), he imposed only two "penalties" (and here I refer to penalties in the broad term – disqualification and monetary penalties).

I am sure that many readers who act as directors, especially non-executive directors of companies, will be somewhat relieved that only two of the directors and officers in the relevant companies were "penalised" (former CFO Romano Nenna was disqualified for two years and ex-CEO Andrew Scott was fined $30,000). In light of the earlier decision and the comments made in this judgment on the nature of the contraventions, there must be some doubt raised as to the utility of sections 1317S and 1318 of the Corporations Act. These provisions enable the court to forgive directors for any breach of duty. Do they have any real use in the context of the scheme of the legislation? In that regard, I remind readers of the legislative scheme that was introduced into the Act following the decision in Daniels v Anderson (which I discussed in my previous note on the first judgment of Justice Middleton in ASIC v Healey (No. 1) 2011 FCA 717 (see Directors Counsel, Company Director, August 2011).

There is little doubt that the Australian Securities and Investments Commission (ASIC) would be disappointed at his decision not to impose more "penalties". At the other extreme, I, and others, remain disappointed that more generosity was not shown by the judge in exercising the discretion available under sections 1317S and 1318 of the Corporations Act. As discussed in my earlier comments, I feel that Justice Middleton did not "do justice" to the ability of directors to delegate and rely on others as provided for in the Act introduced following the decision in Daniels v Anderson. These comments are particularly relevant because the statutory business judgment rule could not be applied.

In the Healey decision, many of the relevant directors were faced with a situation of having to form a judgment on the appropriateness of the relevant accounting principles that were applied by the financial advisers and the auditors and which were complex to them. On this issue there had been some disagreement (in a broad sense) and discussion among experts as to the relevance and appropriateness of certain accounting principles. The way in which these were applied by the relevant directors was found by Justice Middleton to have been inappropriate. But this was not a case where there was an easy assessment of whether one use of the principles overrode another. The classification of the accounts and the way in which they were assessed and applied by most of the relevant directors (although not all of them) was a critical and difficult issue. In these circumstances, Justice Middleton recognised that the directors were entitled to and could rely on experts in assessing critical matters. Those directors who did not review the accounts and who paid little attention to them may be in one position. Other directors, who tried hard to assess and apply the advice of the experts in the field (a matter I shall return to shortly) should, in my view, have been held to have either satisfied their obligations, or at worst to have acted in such a way as to meet the standards required for forgiveness.

It is my view, and a position that Justice Middleton generally supported, that the directors had taken the necessary corporate governance steps in relation to their application of the rules in assessing the accounts. They were held to have taken advantage of the expert accounting advice and outside advice they had received during this period, and had acted honestly and in good faith in reviewing the accounts in those circumstances.

ASIC sought quite severe penalties for each of the directors, including disqualification. Justice Middleton disagreed with the proposals put forward by ASIC. He said the various breaches of the legislation included contraventions of sections 180(1), 344(1) 295A, 296, 297 and 298 of the Corporations Act, as well as sections setting out special provisions applying to these companies – sections 601FD1(1)(b) and 601FD(1)(f). He also held that the directors had not properly addressed the obligations imposed on them under some of these provisions.

But in the context of their application for relief under sections 1317S and 1318, he held that they had acted honestly and in good faith, and that the circumstances were such that no "penalties" should be imposed on any of the them other than those on Nenna and Scott.

He stated that the conduct of the directors was not merely "neglectful".

In his view, this was not a case "of any director failing to exercise due care and diligence with knowledge that he is acting wrongly, contrary to the interests of the company. Undoubtedly, the directors did not properly apprehend their duties but the circumstances in which they found themselves in this position were unusual. While they did not obtain legal advice as to these specific duties, they did retain and properly rely on a range of professional people and organisations in carrying out their responsibilities placed upon them as directors". (at para 137)

As my earlier comments show, I do not agree with his assessment that they should have sought legal advice in the context of their obligations. Their reliance on experts in the field of accounting should have been sufficient.

It is interesting to reflect on his comments at the beginning of his detailed judgment on the question of the severity of any "penalties", forgiveness and related matters: "While the court has taken many factors into account, very much to the forefront of my consideration has been the issue of general deterrence. In my view, the [relevant orders made against the directors] go far enough to indicate the court’s disapproval of the actions of each of the defendants, and to satisfy the requirements of the principle of general deterrence. Any additional penalties are not necessary to facilitate the future adherence of the standard of corporate behaviour found to be required by the court in this proceeding … [various factors] militate very strongly against more excessive penalties. To achieve this balance is in the public interest; to impose greater penalties in the circumstances of this proceeding would not bring about a greater benefit for society or the corporate world, and would otherwise be unfair and inappropriate". (at para 6)

To emphasise the point made here, Justice Middleton noted: "Further, it is important to appreciate that the liability judgment has attracted widespread publicity. The acts and omissions of the directors, as recorded in the liability judgment, have already been the subject of widespread public dissemination. Against such a backdrop of widespread public analysis and associated embarrassment and reputational damage for each of the directors, the need for the imposition of a disqualification order or pecuniary penalty for reasons of general deterrence is much less than it would otherwise be" (at para 177).

But why the judge was not prepared to forgive and excuse the directors under sections 1317S and 1318 is a bit of a mystery. In his judgment, Justice Middleton discusses a number of cases in which those provisions had been applied. He reflected on the fact that while the power and the discretion available to the court is one of "excusing" the contravener, and not necessarily "removing" the breach, it was not impossible for the contravention to be effectively "nullified". As he noted at para 96 of his judgment, there have been cases where the court has made a declaration of contravention and has also made an order under section 1317S relieving an applicant wholly from liability. That relief has rarely been granted to directors; perhaps this was a case in which it should have been considered more appropriate.

It is unclear whether the directors, including those against whom "penalties" have been imposed, will consider appealing the decision. Many will applaud the decision as creating a fine balance in not imposing "penalties" on certain directors, relying on the public "humiliation" and publicity they had already suffered as a result of the detailed litigation and its reporting in the media. But others will be concerned that ASIC was not very successful.

Hopefully, if the defendants do not wish to appeal this decision (and most of them may feel happy to leave the judgment where it lies, with a "black mark" of contravention against them), the High Court of Australia will have the opportunity to review some aspects of penalties and the application of the statutory provisions in this area when the James Hardie appeals are heard later this year. A failure to have a satisfactory resolution of some of these questions will put even greater pressure on the Government to revisit the question of a broader statutory business judgment rule to provide directors with clearer guidance in obtaining relief in appropriate cases.

Professor Bob Baxt AO FAICDLife is an emeritus partner at Freehills and chairman of the Australian Institute of Company Directors’ Law Committee