Faulty shield

Com­pany di­rec­tors must be aware that ig­no­rance of a breach of duty is no de­fence

Australian Transport News - - Contents - An­drew Lacey is a man­ag­ing prin­ci­pal and Luke Do­min­ish a lawyer at McCabes Lawyers T: 02 9265 3214 E: a.lacey@mccabes.com.au

Ig­no­rance of a breach of duty is no de­fence

Com­pany di­rec­tors are gen­er­ally fa­mil­iar with their duty to act with ‘rea­son­able care and dili­gence’. This well-known statu­tory duty finds its home in sec­tion 180 of the

Cor­po­ra­tions Act 2001 (Cth). Sec­tion 180 is oft en used as a “catch-all” pro­vi­sion against di­rec­tors. That is, if a di­rec­tor has breached an­other duty, then they have al­most cer­tainly also breached sec­tion 180 of the Act.

One ex­am­ple of a breach of this duty of care and dili­gence can broadly be cat­e­gorised as a di­rec­tor act­ing with in­for­ma­tion de­fi­ciency – i.e. the di­rec­tor makes a de­ci­sion or con­tin­ues to act in a man­ner with­out the req­ui­site in­for­ma­tion a rea­son­able per­son in their cir­cum­stances ought to re­quire.

In cir­cum­stances where a di­rec­tor is re­quired to have cer­tain in­for­ma­tion in or­der to make a de­ci­sion, then a ques­tion arises: ‘Does a di­rec­tor have a pos­i­tive duty to make en­quiries in or­der to make their de­ci­sions?’

DEL­E­GA­TION

At fi rst in­stance, di­rec­tors will be re­lieved to hear that there are spe­cial pro­tec­tions with re­spect to this duty where the di­rec­tor has del­e­gated their duty.

At gen­eral law, as a di­rec­tor acts in a fidu­ciary man­ner to­wards the com­pany, their du­ties can­not be del­e­gated. How­ever, the law now recog­nises that the ex­i­gen­cies of busi­ness place a great deal of de­mands on a di­rec­tor, and that the com­mer­cial re­al­ity is that di­rec­tors – in ap­pro­pri­ate cir­cum­stances – need to rely on oth­ers.

There­fore, the gen­eral law rule is sup­planted by the op­er­a­tion of sec­tions 198D and 190 of the Act. These sec­tions to­gether state that, bar­ring any­thing con­trary in the con­sti­tu­tion of a pri­vate com­pany, di­rec­tors can del­e­gate their pow­ers to any other per­son, in­clud­ing an­other di­rec­tor or em­ployee of the com­pany. The del­e­gat­ing di­rec­tor is then re­spon­si­ble for all of the ac­tions of the del­e­gate, ex­cept in cir­cum­stances where the di­rec­tor, act­ing in good faith and aft er mak­ing the proper en­quiries, has rea­son­able grounds to be­lieve the del­e­gate is com­pe­tent and re­li­able.

If the del­e­gat­ing di­rec­tor is able to sat­isfy the court that they had this be­lief and the req­ui­site el­e­ments to sup­port it, then it acts as a shield that a di­rec­tor can raise against a claim for breach of duty aris­ing out of the ac­tions of the del­e­gate.

MAK­ING EN­QUIRIES

A di­rec­tor must take rea­son­able steps to place them­selves in a po­si­tion to guide and mon­i­tor the man­age­ment of the com­pany.

This will gen­er­ally mean that a di­rec­tor must be­come fa­mil­iar with the aff airs of the com­pany, keep in­formed as to its ac­tiv­i­ties, and main­tain fa­mil­iar­ity with its fi nan­cial sta­tus. How­ever, as the NSW Court of Ap­peal held in Daniels v An­der­son (1995) 37 NSWLR 438 (Daniels), a fur­ther duty to make en­quiries can be en­livened in the fol­low­ing cir­cum­stances:

“If … di­rec­tors know, or by ex­er­cise of or­di­nary care should have known, any facts which would awaken sus­pi­cion and put a pru­dent man on his guard, then a de­gree of care com­men­su­rate with the evil to be avoided is re­quired, and want of that care makes them re­spon­si­ble.”

This means that a di­rec­tor must keep in­formed as to the aff airs of the com­pany, and if they know or should have known about facts that would have put a rea­son­able per­son on guard, then they should make en­quiries into those facts.

There­fore, once a di­rec­tor’s suspicions have been awak­ened, there is a pos­i­tive duty on the di­rec­tor to sat­isfy them­selves that no con­tra­ven­tions have oc­curred.

This test was re­cently con­sid­ered by Rob­son J in the colour­ful case of ASIC v

Flugge & Geary (2016) 342 ALR 1 ( Flugge). This case con­sid­ered whether two former di­rec­tors of the Aus­tralian Wheat Board ( AWB) had breached their du­ties re­gard­ing AWB’s con­tra­ven­tions of in­ter­na­tional law.

“A di­rec­tor must keep in­formed as to the af­fairs of the com­pany”

The al­le­ga­tion was that the AWB had paid hard cur­rency to the Iraqi govern­ment in re­sponse to sham fees for the de­liv­ery of wheat to Iraq.

These pay­ments were con­trary to UN Res­o­lu­tions in place at the time. ASIC brought pro­ceed­ings against the di­rec­tors, al­leg­ing that they knew about the con­tra­ven­tions, or if they did not know, they should have made en­quiries that would have led them to stop­ping the con­tra­ven­tions.

Rob­son J, in a lengthy judg­ment, ul­ti­mately held that Flugge, the former chair­man of AWB, did not know that con­tra­ven­tions were oc­cur­ring, but that he did breach sec­tion 180 of the Act by fail­ing to make en­quiries.

He quoted the words of Pol­lock J from the Supreme Court of New Jersey in the United States, say­ing: “Di­rec­tors may not shut their eyes to cor­po­rate mis­con­duct and then claim that be­cause they did not see the mis­con­duct, they did not have a duty to look. The sentinel asleep at his post con­trib­utes noth­ing to the enterprise he is charged to pro­tect.”

His Hon­our found that Flugge had breached his duty as he was aware of a com­plaint levied by the UN against the AWB, which should have been suf­fi­cient to awaken his suspicions, and he failed to make any en­quiries as to the pro­pri­ety of the pay­ments which were the sub­ject of the com­plaint. Flugge was ul­ti­mately pe­nalised $ 50,000 and was dis­qual­i­fied from man­ag­ing a cor­po­ra­tion for fi ve years.

IM­PLI­CA­TIONS

While the case of Flugge has an un­usual fac­tual ma­trix that many Aus­tralian com­pa­nies would rarely fi nd them­selves in, the case stands out as a fi rm re­minder that di­rec­tors have a duty to pos­i­tively make en­quiries. De­spite Flugge not be­ing aware of any con­tra­ven­tions, he was still in breach of his duty to act with rea­son­able care and dili­gence.

It sends a mes­sage to com­pany di­rec­tors that, if they are aware that there may be a pos­si­ble breach of the law tak­ing place, or a breach of duty, it is not suffi cient to shut their eyes or rely on the in­for­ma­tion of oth­ers.

A di­rec­tor is re­quired to be alert and cu­ri­ous, ready to jump into the trenches and sat­isfy them­selves that noth­ing im­proper is tak­ing place.

Any­thing short of this may re­sult in a civil penalty be­ing levied against the di­rec­tor who is asleep at their post.

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