This article first appeared in the March 2011 edition of Boardroom magazine.
The fall-out from the strategy deployed by James Hardie Industries Ltd to limit its exposure to asbestos claims has provoked a searching examination in the Australian courts of exactly what happened at the board meeting when the critical decisions were taken.
The controversy surrounding JHIL’s corporate restructure in 2001 to segregate its compensation liability from the rest of its business and the ensuing litigation has attracted intense media and market interest and will be relevant in New Zealand, especially in relation to what it says about directors’ duties and governance issues more generally.
But first, some context.
The James Hardie group, the leading manufacturer of asbestos products in Australia until 1987, had conducted this business since 1937 through two wholly-owned subsidiaries (“Amaca” and “Amaba”). By 2001 these companies were no longer in production and, as the primary recipients of the asbestos claims, had become, according to the New South Wales Court of Appeal, “something of a millstone around the group’s neck”.
JHIL had been exploring restructuring options for some while. There had been significant discussion at board level about the sensitivities involved and about the need, while protecting the company, to be able to assure stakeholders that there would be sufficient money to meet all present and future claims.
The final proposal, approved by the board on 15 February 2001 and later endorsed unanimously by JHIL shareholders, was to create a trust – the Medical Research and Compensation Foundation – in which Amaca’s and Abaca’s shares would be vested plus other assets to a net value of $293 million. This was supported by an actuarial estimate that liabilities would not exceed $293 million. In addition, a Deed of Covenant and Indemnity (DOCI) was entered indemnifying JHIL from any claims.
The Foundation had been in existence barely two years, however, when it was reporting a serious shortfall in funds. Estimated claims had billowed to $1.57 billion and would soon pass the $2 billion mark; and JHIL was refusing to accept liability on the basis that the Foundation was a separate legal entity. A judicial Commission of Inquiry was appointed in February 2004. It found JHIL was under no legal obligation to meet claims but was highly critical of the company’s conduct and – in December 2004 – JHIL bowed to political pressure and agreed to establish a voluntary compensation fund.
The latest chapter in the legal saga was when the New South Wales Court of Appeal, in December last year, set aside the penalties and disqualification orders that had been awarded against the non-executive directors of JHIL and overturned a trial court declaration from 2009 that they had breached their duty of care.
The appeal turned on a question of fact – whether the board had approved a draft release to the ASX which stated that the Foundation would be fully funded to meet all claims. Other information before the board, in particular a paper which referred to the “central communications conundrum” that they would be unable to make such an assurance, meant that the directors would have been aware that this statement was misleading.
The trial court was satisfied that the draft announcement was put before the board on 15 February “for one purpose only” – to approve it. However the Appeal Court disagreed, saying it could not be established to a sufficient degree of proof that the board had approved the draft or was ever intended to. It had been presented to them expressly as subject to “refinement”, had yet to be vetted by JHIL’s legal and other advisers and was “materially changed” after the meeting.
The Court found this despite the fact that the minutes, which had been signed off by the board chairman and accepted by the other directors without demur, recorded that the board had approved the announcement for release. The minutes, which had been drafted in advance of the meeting, were found to contain a number of inaccuracies.
The Australian Securities and Investments Commission (ASIC) had invited the Appeal Court through cross-appeals to find that the directors were also in contravention of their obligations for failing to inquire into the robustness of the actuarial analysis for the Foundation. (The external experts that JHIL had commissioned to review the cash flow estimates had been asked to report only on the logical soundness and technical correctness of the model, not on the assumptions underpinning it. These included an assumption of an 11.7% return on investments.)
Because the other contraventions ASIC was seeking rested on the board having approved the announcement, they were also set aside. However the Court of Appeal was clear that, had the directors approved the release, it would have constituted a breach of their duty to act with the required care and diligence. In particular, the Court said that they were all alert to the sensitivity of the modelling in establishing the sufficiency of the Foundation’s funding so should have inquired into the numbers rather than relying on “blind acceptance” - particularly given the assumed 11.7% investment return.
“We do not think this was an occasion of reasonable reliance on management or others,” the Court said.
Directors’ duties are now under focus in New Zealand also, and will be increasingly as the Government tries to promote the share market as an investment choice for Mum and Dad investors. Take-outs for the New Zealand director of a listed company from the JHIL experience are:
- especially in relation to key strategic decisions, directors must take reasonable steps to inform themselves of all relevant issues. It is not enough to simply rely on sign-offs from other board members, senior management or external advisers without applying one’s own judgement
- advice must be treated critically - disclaimers, qualifications and assumptions can leave large information “gaps” and directors should be satisfied that there are no gaps which are significant for their decision
- ensure meeting procedures are clear with formal resolutions on important matters
- check the minutes from board meetings to ensure they are a true record
- if asked to approve a release to the media or to the stock market, ensure that the statement is accurate in tone and content
- remember that the test for materiality under the NZX continuous disclosure regime is not subjective but objective, and will be applied by regulators and courts with the benefit of hindsight, and
- if lacking key information/documentation/expertise to participate in a decision, pursue a policy of active abstention rather than passive acquiescence (two of the JHIL directors were participating in the discussions by phone from the US and were criticised by the trial court judge for neither ensuring that they had a copy of the draft ASX announcement nor abstaining from the vote).
Geof Shirtcliffe is a partner at Chapman Tripp specialising in corporate law.
We will discuss further aspects of this case in the April Boardroom.