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Brief Counsel

"Landmark" Australian case finds the buck stops with the Board

28 June 2011

​The Australian Federal Court yesterday issued what the Australian Securities and Investments Commission (ASIC) has described as a “landmark decision” which highlights the dangers of boards uncritically relying on management, or the auditors.

The judgment in ASIC v Healey draws on the Feltex case last year and will be influential in New Zealand, especially given the Financial Markets Authority’s new powers to take action in relation to directors’ duties.

This may not be the last word on the matter, however, as an appeal is likely.

ASIC’s response

ASIC welcomed the judgment, saying that it sent a clear message to boardrooms across the country about corporate accountability:

“Each member of the board must bring and apply their own skills and knowledge when declaring financial statements are true and fair.  This is not a responsibility company boards can delegate or merely rubber stamp.  It’s not enough for directors just to be present”.

The facts in brief

The charges related to the 2007 annual reports of Centro Properties Group and Centro Retail Group and to the non-disclosure of significant short-term debt and certain related-party guarantees, entered into after the balance date, which significantly affected the Group’s financial position.  

The issues before the Court were:

  • whether the eight directors charged knew or ought to have known of this information when they signed off the statements, and 
  • whether they had taken due care and diligence in the exercise of their duties under the Corporations Act (the Australian equivalent of the New Zealand Companies Act).

The directors - all of whom the Judge said were intelligent, financially literate and experienced – pointed to the fact that the errors had not been detected by anyone in Centro’s accounting team or by Centro’s auditors.

However the Judge said that, while the failure to notice certain omissions may well be explicable, the “central question” was whether the directors had applied their own minds and their own knowledge of the company’s affairs to the accounts before approving them. 

And the judge found the evidence showed that they had not.  Instead they had “in some cases on their own admissions, clearly looked solely to management and external advisors”.  Had they taken more care and acted as “the final filter”, the errors may have been discovered earlier.

The Australian Court on the Feltex case

The Judge did not accept the Ministry of Economic Development’s argument to the New Zealand District Court that the Feltex directors “should have done it all themselves and become familiar with the complexities of various accounting standards”, instead affirming the New Zealand Court’s view that directors are entitled to rely upon specialist advice.  But, before relying on it, they must take all “reasonable steps” to ensure the accuracy of the advice.

“What each director is expected to do is take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her.”

Whether this obligation of care had been met would depend on the facts of the case, the complexity of the entity’s business, the internal reporting procedures within the entity, and “the nature of the task the director is obliged to undertake.”

The Judge was critical of the Centro directors for relying exclusively on the advice of others.  “No director stood back, armed with his own knowledge, and looked at and considered for himself the financial statements.”

“A director is an essential component of corporate governance.  Each director is placed at the apex of the structure of direction and management of the company.  The higher the office that is held by a person, the greater the responsibility that falls upon him or her.”

Implications for New Zealand

The Australian Court applied similar principles as were applied in the Feltex case, but there are also some important differences between the two cases.

The Feltex litigation was a criminal proceeding over a specific strict liability provision in the Financial Reporting Act.  Centro involved not only breach of reporting obligations but also a breach of general directors’ duties and was a civil proceeding seeking pecuniary penalties.  The burden of proof was therefore lower, and the Judge was cautionary about what level of penalty might be appropriate.

At the time of the Feltex case, there was no ability in New Zealand for the regulator – then the Securities Commission – to take action against a director for breach of directors’ duties.  The new Financial Markets Authority (FMA) does, however, have this power under section 34 of the Financial Markets Authority Act.

Moreover, the Government has made a preliminary decision through the Securities Law Review to increase the FMA’s powers in this area by giving it the right to take criminal proceedings against directors – but only for egregious misconduct with no provision for civil remedies.

The relevant Cabinet Paper says: “A criminal offence is appropriate where the conduct in question will cause substantial harm to individual or public interests.  On the other hand, civil penalty provisions, with the lower standard of proof, i.e. cases being judged on the balance of probabilities, would result in too great a risk of people being deterred from taking on directorships.  They would also put the regulator in the position of second-guessing the soundness of directors’ business decisions.”

These jurisdictional differences aside, the Centro judgment - if upheld – will be influential in the New Zealand courts.  A further elucidation of directors’ duties in the New Zealand context is likely with the release (probably late next week) of the Nathans Finance decision.

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