ICAC throws up challenges

A recent ruling that directors may have engaged in corrupt conduct may not be sufficient to sustain an allegation of a breach of the Corporations Act, writes Professor Bob Baxt.

The years 2013 and 2014 will certainly go down in history as “highlight years” of the controversial NSW Independent Commission Against Corruption (ICAC). A significant part of the hearings involved allegations arising out of the activities of the Obeid family. The rulings of ICAC have been “spectacular”. Of course, any recommendation or decision made by ICAC that corrupt activity has occurred does not automatically mean that any breach of the law has occurred, or that any prosecution will follow. But, in the context of the Obeid findings (and there have been a number of them) it is not surprising to see not only prosecutions being pursued but also challenges being made to ICAC’s allegations.

One of the allegations surrounding the operations of the Obeid family has led to the potential prosecution in New South Wales of directors who were involved in the operations of White Energy. This company acquired certain mining tenements originally purchased by Cascade Coal from the Obeid family. Cascade Coal entered into negotiations to sell the company for $500 million to White Energy. ICAC had ruled that the relevant directors of White Energy, apart from their allegedly corrupt behaviour, were also in breach of section 184 of the Corporations Act 2001. The breaches are said to have arisen because they had failed to disclose relevant information about the alleged corrupt activities to their company White Energy.

In Duncan v ICAC [2014] NSW 1018 the New South Wales Supreme Court was asked to consider whether the findings/rulings of ICAC in relation to these dealings, which could lead to criminal prosecution, also amounted to alleged breaches of the Act. These questions were put to the court on a number of bases by the directors of White Energy. They had hoped that this challenge would in effect nullify the ICAC rulings and bring to an end further potential liability. Four of the directors, Duncan, Poole, McGuigan and Atkinson were unsuccessful in their attempt to have the corruptions findings made by ICAC overturned (Kinghorn, the remaining director was successful).

But the four directors did obtain a positive decision from Justice McDougall in the Supreme Court of New South Wales, who found that the rulings made by ICAC that they had breached section 184 of the Act were not supported in law.

As some may know, section 184 of the Act is a provision that imposes a range of obligations upon directors to act in good faith, not to use their position or information in inappropriate ways, and other related obligations. Failure to establish an appropriate defence to charges brought pursuant to this section might lead to a criminal offence being ruled against them. ICAC had alleged that the relevant directors had failed to disclose the corrupt involvement of the Obeid family in the relevant transaction in relation to White Energy and that this was a deliberately reckless act resulting in a breach of section 184.

Justice McDougall, whilst he dismissed the challenges made against the findings of ICAC based on issues of natural justice and other principles, was more favourably disposed towards the directors in relation to section 184. The directors argued that they had fully disclosed to White Energy the fact that they had conflicting interests in the particular transaction. They had removed themselves from the negotiations that took place between White Energy and Cascade Coal and an independent board committee of the company had been established to deal with those negotiations. Furthermore, the directors argued that there was no positive duty or obligation imposed upon them pursuant to section 184 of the legislation to disclose the alleged corrupt behaviour. That provision, they argued, did not require directors to bring to the attention of the company factors that might have led to allegations of corruption or similar allegations being made against the directors.

Justice McDougall agreed that the directors of White Energy were not acting in their capacity as directors during the relevant transaction because they had in fact excused themselves from the negotiation process. The relevant independent committee referred to earlier was responsible for that transaction. His observations on the interpretation of section 184 of the Act are most interesting. He noted:

“Even accepting, for the moment, that directors were ‘intentionally dishonest’ in their dealings with Mr Cubbin [the independent board committee’s chairman] that did not occur in the exercise of any of their powers as directors, nor in the discharge of any of those duties. I should add that each of the directors challenged the findings of intentional dishonesty. On the view to which I have come, it is not necessary to deal with that challenge.” (See paras 207-208).

Was there in fact a positive obligation of directors to disclose a potential breach of other laws in carrying out their actions, even if they were not in fact acting at the particular time as directors of the relevant company? This is an interesting question and can raise some very specific problems for courts dealing with the broad obligations of directors to act with appropriate care and diligence. The failure to comply with the law (in general terms) will expose the company to potential liability under other statutes, which may in turn result in financial damage to the company if a positive breach of the law is held to have occurred.

If the directors have acted in a way that led to that particular breach should they not be accountable for a breach of their statutory duty of care and diligence? This was an issue that the full Federal Court agreed with in the Fortescue Mining case (ASIC v Fortescue Mining Limited & Forrest (2011) 81 ACSR 563). In that case the court ruled that Andrew Forrest, the CEO of Fortescue Mining, by engaging in conduct which the Full Federal Court found to be misleading or deceptive, and failing to ensure that the company complied with continuous disclosure provisions of the Act, was in breach of his duty of care and diligence. It upheld the ASIC prosecution against Forrest for breach of his statutory duty of care and diligence. Because the High Court of Australia reversed the full Federal Court’s decision in that case these findings and rulings were of no relevance in the final outcome of the matter. However, the significant judgment of Chief Justice Keane of the Federal Court (now a member of the High Court of Australia) is regarded as a decision of significant importance in dealing with this particular issue.

Returning to the ruling by Justice McDougall in relation to this matter, it is important to consider his language in dismissing the allegations that the directors had breached their duty under section 184. He noted:

“No doubt, there may be situations where, to observe the proscriptive obligations imposed on fiduciaries, it may be necessary for a fiduciary to form some positive act. But that does not mean that there is a proscriptive element to the fiduciary duty. It means that, to avoid a conflict of interest (or to avoid profiting at the expense of the beneficiary), it is necessary for the fiduciary to take some positive step. This is not such a case. The directors were in a position of conflict. They stood to profit if White Energy exercised the option to acquire the shares in Cascade Coal. But they had removed themselves from the conflict, and left to others the question of whether the option should be exercised.” (At paras 205-206).

This interesting observation of Justice McDougall throws into harsh relief once again the conflicting views that are continually being expressed by the media, politicians and by others (even may I say by ASIC) in promoting the virtues of the ASX Corporate Governance Council’s principles of corporate governance. These principles are highly laudable, but unless companies have their shares or other securities listed on the ASX, they do not generally have attached to them any legal obligation.

Companies are not required by law to comply with these principles; they are nevertheless regarded as highly valuable and desirable to be implemented. But, there is the further possibility that a company will be in breach of the Commonwealth Criminal Code 2001, which is a binding statute on all companies, and requires companies to observe a culture of compliance and to ensure that steps are taken to avoid breaches of any laws that may impact upon them and their company. Such breaches may trigger a liability in scenarios where what the directors are engaged in is significant, even if it is not a matter that relates to their specific duties as directors of a company and do not fall foul of the principles of company law either under the general law or under the Act. A breach of the law may nevertheless trigger potential liability for companies.

There is a very real need, as I have expressed in the pages of this magazine in the past, for some rationalisation to be made in the development of the corporate governance principles (now to their third edition) and their interaction with the law. The Australian Institute of Company Directors recently released a new important initiative involving the establishment of sensible defences for directors in their ground breaking paper, The Honest and Reasonable Director Defence: A Proposal for Reform.

It is unclear whether the government will respond positively to this initiative by Company Directors. It has been promoted and pursued because there is a general belief by Company Directors, and by many lawyers and others in the community, that the current statutory business judgment rule (SBJR) contained in section 180(2) of the Act is ineffective and is not wide enough. Before we even worry about whether we should have a defence of this kind applying across the board, we should make sure that directors are not led to believe, quite wrongly in my view, that they have a legal obligation to comply with the principles of corporate governance. Whilst it makes great sense for directors to be as law abiding and as observant of these principles as is possible, it may well be that at times there is a clash between what the principles of corporate governance may suggest is appropriate and what company law suggests is required. The company law is clearly the relevant law to be followed in such situations in my view: it is the view I believe the High Court of Australia has supported; but at this time the matter remains one of conjecture given that it was not possible for the High Court to adjudicate in the Bell Group litigation.

The Obeid activities and the operations of ICAC in that sphere are likely to produce some other interesting decisions of our courts in the not too distant future. There will be a great deal of material to evaluate and discuss in a proactive and sensible way as these cases’ judgments proceed to finality.