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Further lessons from a corporate catastrophe

05 April 2011

​This article first appeared in the April 2011 issue of Boardroom magazine.

In last month’s Boardroom, we looked at the implications for non-executive directors of the litigation arising from the doomed attempt by James Hardie Industries Ltd (JHIL) to reduce its asbestos risk.  Now we look at the lessons for chief executives and members of board committees.

It may be useful at this point quickly to recap the chain of events which precipitated the crisis.  The company had been exploring for some time options to inoculate the rest of the business from its asbestos exposure as Australia was about to adopt accounting standard changes which would have required JHIL to include in its balance sheet a provision for future asbestos liabilities. 
Both senior management and the board recognised that the saleability of the restructure hinged upon being able to satisfy the market and asbestos victims that there would be sufficient funding to meet present and future claims.
The final proposal, approved by the board on 15 February 2001, was to create a trust – the Medical Research and Compensation Foundation – in which the shares of the two subsidiary companies responsible for the group’s historic asbestos production would be vested, together with other assets to a net value of $293 million.  In return, a Deed of Covenant and Indemnity (DOCI) would be entered indemnifying JHIL from any further liability.
But the strategy failed spectacularly.  Within two years of implementation, the Foundation was reporting a serious shortfall in funds.  Within four years, JHIL was the subject of a judicial Commission of Inquiry.  Within nine years, hefty disqualification orders and penalties had been awarded against the CEO, the CFO, the General Counsel and the seven non-executive directors who participated in the 15 February board meeting.
All parties except the CEO appealed.  As discussed in our March Boardroom, the appeals by the non-executive directors were successful.  But those by the CFO, Phillip Morley, and the GC, Peter Shafron, largely failed.

Findings against the officers

Shafron was found to have breached his duty of care and diligence on two counts:
  • failure to inform the board that the actuarial assessment underpinning the funding allocation to the Foundation was not based on the most recent data and had only a 50% probability of being achieved, and
  • failure to advise the CEO and the board that the DOCI should be notified to the market under JHIL’s continuous disclosure obligations.

Shafron sought to use as a defence the fact that he had not actually participated in the decision-making, but the Court found that “it is a reality of corporate life that board and other important decisions involve many persons other than the ultimate decision-makers”.

The Court also rejected Shafron’s argument that a law firm represented at the board meeting should have advised that the DOCI came within the continuous disclosure rules.  The Court said that the obligation lay with JHIL as JHIL had not explicitly sought the firm’s advice on the issue.  This was not to suggest that Shafron’s duties were “non-delegable” but that, if they were going to be delegated, there had to be a specific delegation.

The judgment was also critical of Shafron for failing to advise the board that a draft ASX statement on the establishment of the Foundation was “too emphatic” regarding the sufficiency of the Foundation’s funding.  He argued that this was not necessary as he had told the board many times that the actuarial estimates were subject to qualifications and uncertainty.  In the event, no breach was found against him for this lapse.  But the Court was clear that it would have reached a very different conclusion had the board in fact approved the announcement rather than just considering it as a work in progress.

Morley was found in contravention for failing to advise the board that the reviews of the cash flow modelling by external expert advisers were restricted to the logical soundness and technical correctness of the model and explicitly excluded consideration of the key assumptions informing the estimates, including an assumed 11.7% annual return on investments.

New Zealand vs Australian law

The Australian Corporations Act, unlike the New Zealand Companies Act, places the same duties of care and diligence on “officers” of the company as on directors.  However the effect of the two statutes is in a number of cases similar.

The Companies Act defines director to include “a person to whom a power of duty of the board has been directly delegated.”  Typically this will be the CEO (and may sometimes include others, such as the CFO).  A CEO acting under delegated authority from the board is a “deemed director” and accordingly is required to exercise the care, diligence and skill of a reasonable director in respect of that role.

The Act also provides that directors must exercise their duties taking into account, amongst other things, “the nature of the responsibilities undertaken”.  A director who has agreed to sit on a board committee – for example, an ad hoc committee to supervise the governance of a transaction – may well have more extensive obligations than non-committee members.

In either case, failure by the CEO or committee members properly to inform the main board of all matters material to the decision might mean they are found liable for breaching their duty of care (as directors) even if the other board members, who relied on them, were not.

Take-outs for CEOs and Members of Trust Committees

  • Ensure that you understand the full extent of your responsibilities.  
  • For important or sensitive decisions, err on the side of caution – even to the extent of telling the board things you think are obvious or that they already know.  
  • Do not rely on the presence of outside advisers unless they have been specifically delegated to provide advice.
  • Carefully consider the information and advice received as a whole, and ensure that any “gaps” (such as untested assumptions or material limits on advice) are identified for the board.

Geof Shirtcliffe is a Chapman Tripp partner specialising in corporate and securities law.  

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