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In the hot seat: are chairmen subject to a higher standard of care than other directors?

12 May 2003

A recent Australian case indicates that the chair may indeed be a hot seat. This Counsel discusses the factors that may make it hot, and possible implications for chairmen in New Zealand.

Key points

A recent decision by Austin J. of the New South Wales Supreme Court highlights the potential for some company chairmen to be subject to a higher standard of care than other directors because of their additional responsibilities.

Depending on the final judgment and any appeal in this case, Austin J. indicates that:

  • A chairman’s responsibilities depend on their role in the company in fact and not the specific tasks delegated to them through the company’s constitution.
  • Where a director is chairman of a large public company; has relevant qualifications and experience; and holds other positions or offices in the company relevant to its financial management or performance then there may be grounds for arguing that their responsibilities are more than ceremonial or procedural and that they should be subject to a higher standard of care.
  • Non-executive directors may not be entitled to assume that they are kept fully informed at the company’s board meetings, and may be required to make further enquiries in circumstances where a reasonable person would have been put on notice.

All directors are under a continuing obligation to keep themselves informed about the activities of the company and, in particular, its financial status.

Introduction

The $600-million collapse of Australian telecommunications company One.Tel Limited has resulted in a flurry of media activity and legal debate.

Much of this debate has centred on the role of the board of directors in the company’s demise with the controversial decision of the NSW Supreme Court in ASIC v Rich suggesting that the non-executive chairman of the board of directors of One.Tel may have had a number of substantive responsibilities. These included responsibilities relating to:

  • the general performance of the board
  • the flow of financial information, and
  • the maintenance of cash reserves and solvency.

Accordingly, the suggestion in ASIC v Rich is that the non-executive chairman was subject to a higher standard of care.

In this Counsel we consider the rationale behind the decision in ASIC v Rich and the potential implications for company directors both in Australia and New Zealand.

The decision in ASIC v Rich1

ASIC v Rich involved an application for summary dismissal by One.Tel’s former chairman of the board of directors, Mr Greaves. Mr Greaves (along with One.Tel’s three executive directors) was sued by ASIC for $92 million, for breach of his statutory duty of care.

Mr Greaves applied to strike out the claim against him primarily on the grounds that he was a non-executive director and in essentially the same position as the other three non-executive directors, none of whom had been sued.

In dismissing the application and finding that ASIC’s statement of claim disclosed a reasonable cause of action against Mr Greaves, the Court rejected Mr Greaves' submission that a chairman’s responsibilities were necessarily confined to ceremonial or procedural matters or to the specific functions delegated to that director.

Rather, the Court found it reasonably arguable that the responsibilities of the chairman depended on the role of the chairman in the company in fact, including any specific tasks or additional responsibilities undertaken by him, any qualifications and experience relevant to his directorship and any remuneration paid for his services.

In this case, Mr Greaves was not only chairman of the board of directors of One.Tel, but was also:

  • a founding director
  • chairman of the finance and audit committee
  • a qualified accountant with significant commercial and financial experience, and
  • paid $50,000 per annum for his services.

On these facts the Court found that the Commission had a reasonably arguable case that in addition to his procedural obligations Mr Greaves had a responsibility to:

  • take reasonable steps to ensure that he and other members of the board monitored management of the One.Tel Group, properly assessed One.Tel’s financial position and performance, and properly and promptly detected and assessed any material adverse development affecting its financial position or performance
  • take reasonable steps to ensure that he and other members of the board were informed of all material financial information concerning the One.Tel Group, including information about cash reserves, actual segment performance and key transactions
  • establish and maintain systems for information flow to the board
  • employ a finance director with the appropriate skills and qualifications
  • take reasonable steps to ensure that public statements made on behalf of the company did not mislead the ASX or the public
  • take reasonable steps to ensure the company was operating within its cash reserves, and
  • make recommendations to the board as to the prudent management of the company, including recommendations about its funding requirements, cessation of its business and/or appointment of an administrator.

In coming to this conclusion, the Court cited various reports and academic writings referred to in the Commission’s submission, including The Responsibilities of the British Public Company,2 which stated that:

"It is the function of the chairman to see that policies are initiated, to secure the agreement and approval of his board for what they consider to be the right policies, and to ensure by appropriate instructions and continued monitoring that the policies are put into effect by those with executive responsibilities."

The Court also found support from the first instance decision of Rogers J. in AWA Limited v Daniels3. In considering a chairman’s non-procedural functions, Rogers J. commented that:

"The chairman is responsible to a greater extent than any other director for the performance of the board as a whole and each member of it. The chairman has the primary responsibility of selecting matters and documents to be brought to the board’s attention, in formulating the policy of the board and in promoting the position of the company."

While not an issue on appeal in this case, nothing said by the Court of Appeal in the course of its judgment disturbed Rogers J’s findings.

The law relating to directors’ duty of care

ASIC v Rich provides some of the first judicial commentary on the new section 180(1) Corporations Act 2001, which governs directors’ duty of care in Australia. Section 180(1) provides that:

"A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

- were a director or officer of a corporation in the corporation’s circumstances; and

- occupied the office held by, and had the same responsibilities within the corporation as, the director or officer."

By incorporating the concept of a reasonable person, section 180 sets an objective standard of care for all directors, albeit qualified by subjective considerations. These considerations include the corporation’s circumstances, the office held by the director and the director’s responsibilities.

In regard to the corporation’s circumstances, matters which are relevant to determining duty of care include the size of the corporation, whether it is publicly listed, its financial position, and its organisational structure. Also relevant will be the "responsibilities" of the director.

In considering a director’s responsibilities, a distinction has traditionally been drawn between executive and non-executive directors, with the courts imposing a much lower standard of care on non-executive directors.

ASIC v Rich suggests there may be questions as to the validity of this distinction where the non-executive director is also company chairman, occupies additional roles within the organisation relating to its financial management or performance and is well qualified and highly paid. In such circumstances, it suggests that there may be grounds for arguing that the non-executive director has substantive responsibilities and, pursuant to section 180(1), should be subject to a higher standard of care.

This view is consistent with the Court’s comments on the duty to keep informed. Criticising earlier judgments which have imposed a significantly lower threshold on non-executive directors, Austin J. indicated that all directors are under a continuing obligation to keep informed about the activities of the corporation and, in particular, its financial status. His Honour further indicated that "if the duty to keep informed exists for all company directors, it must be a duty imposed on the company chairman whose responsibilities may be enhanced".

Depending on the outcome of the final judgment, these comments appear to place a greater burden on non-executive directors, and particularly chairmen, to keep themselves informed of the company’s activities. In making these comments, Austin J. casts doubt on earlier decisions finding that non-executive directors are entitled to assume they are kept fully informed at the company’s board meetings and are not required to make further enquiries, even if put on notice.4

The implications of ASIC v Rich for company directors in New Zealand

The New Zealand equivalent of section 180 is section 137 of the Companies Act 1993, which provides:

"A director of a company when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation –

1. the nature of the company

2. the nature of decisions; and

3. the position of the director and the nature of the responsibilities undertaken by him or her."

Like section 180, section 137 creates an objective test qualified by a range of subjective considerations. This indicates that also like section 180, it is the director’s role in the company in fact which will be relevant to determining duty of care.5

Factors which can be taken into account under section 137, and which may lead to the imposition of a higher standard of care, include:

  • whether the director is chairman of the board
  • whether the director has undertaken additional roles or responsibilities in the company
  • whether the director has particular qualifications relevant to their directorship.

It remains to be seen, however, whether the New Zealand courts will go so far as to find that the chairman of the board of directors of a large public company should prima facie be subject to a higher standard of care.

What is clear is that the decision in ASIC v Rich is in line with commercial reality and public expectations, both in Australia and New Zealand. In the wake of a number of well-publicised company collapses, large public companies in particular are under increasing legal and public scrutiny and are placing greater reliance on their board of directors to withstand such scrutiny. In turn, chairmen are becoming better qualified, more experienced and demanding better compensation. In these circumstances it seems fitting that they should also be subject to a higher standard of care.

"It is now commonplace to observe that the standard of care expected of company directors, both by the common law and under statutory provisions, has been raised over the last century or so. One might correspondingly expect that the standard for a company chairman has also been raised."6

Conclusion

While the Court’s decision in ASIC v Rich was limited to a finding that ASIC’s statement of claim disclosed a reasonable cause of action against Mr Greaves, it does sound a warning bell that the chairman of a board of directors may have a greater duty of care. Directors on both sides of the Tasman are no doubt awaiting with great interest the final judgment and the result of any appeal.

Endnotes

1. [2003] NSW SC 85 (24 February 2003).

2. The Final Report of the Company Affairs Committee as endorsed by the Confederation of British Council, 19 September 1973.

3. (1992) 7 ACSR 759.

4. (1993) 11 ACLC 286.

5. Cassidy J. An evaluation of section 232(4) of the Corporations Law and the Directors’ duty of due care, skill and diligence. ABLR Volume 23, June 1995, 185.

6. [2003] NSW SC 85 (24 February 2003) para 71.

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