Directors duties and the business judgment rule: Justice Austin offers some clarification

The case of ASIC v Rich provides us all with some valuable commentary on directors duties and the potential application of the business judgment rule.

Directors Duties and the Business Judgment Rule

One.Tel created headlines in May 2001 when it was placed into voluntary administration. ASIC asserted that chief executives Jodee Rich and Brad Keeling, chief financial officer Mark Silbermann and chairman John Greaves had failed to disclose the liquidity situation to the Board.

ASIC commenced proceedings against the four directors and officers of One.Tel, alleging that they had access to information regarding the true financial position of the Company that they withheld from the Board and the ASX. ASIC maintained that this constituted a breach of their duties under the Corporations Act 2001.

In March 2003, Keeling accepted orders that banning him from being a company director for a period of ten years and that he pay $92 million compensation to the Company. Similarly, Greaves agreed to accept orders banning him from managing a corporation for four years and compelling him to pay $20 million compensation to the Company.

Rich and Silbermann proceeded to trial in the New South Wales Supreme Court where they were acquitted by Justice Austin.

ASIC alleged that the directors had breached their statutory duty of care of diligence. This duty imposes the obligation to take reasonable care and perform the necessary due diligence when executing a business decision. ASIC did not point to specific conduct that constituted the breaches of duty. The regulator instead pointed to the general conduct of withholding financial information.

The judgment provides an excellent examination of directors duties. His Honour referred to his previous rulings in Vines v ASIC where he had stated that the statutory duty of care originated from torts law. In particular, Justice Austin extrapolated:

• that a ‘company’s circumstances’ requires consideration to be given to the type of company, the size, and the industry it is involved in, its constitution, the composition of the board and the distribution of work between corporate officers;
• a reference to the same responsibilities within the company is not limited to specific tasks delegated to the officer via formal means;
• that there must be a distinction between a breach of the duty of care contained in the Corporations Act 2001 and mere errors or mistakes.

Justice Austin also delved into the largely unexplored realms of the business judgment rule. The business judgment rule provides a defence for directors who may have breached the duty of care if they made the judgment in good faith, for a proper purpose, did not have a material personal interest, appropriately informed themselves about the subject matter, and rationally believed that the decision was in the best interests of the company.

The judgment provides some direction for the seemingly awkward future of this defence in Australia. As the rule did not apply in Rich’s case, what his Honour said cannot be held to be binding on other courts.

His Honour stated that the evidence presented by ASIC did not establish its case against the defendant directors. ASIC had provided a vast volume of evidence which attempted to establish that the general conduct of the directors constituted a breach. Justice Austin stated that the regulator needed to point to specific conduct to establish a breach on the balance of probabilities.

According to the judgment, ASIC made some other evidentiary mistakes including:

• failure to call witnesses to explain vague documentation;
• the use of an expert witness with a possible conflict; and
• alleging that One.Tel’s financial situation should be viewed from an Australian perspective whereas One. Tel’s finances could not simply be taken in an Australian context because the company’s treasury was so tied up in other countries.

On 5 February 2010, the Court handed down orders that ASIC pay Rich’s and Silbermann’s legal costs, amounting to almost $14 million.

Recommendations

The first point to demonstrate compliance with obligations of directors and officers is always documentation including signed minutes of any meetings.

As the duties of directors and officers are assessed having regard to the factors enunciated by Justice Austin, it is important that the roles of officers and executive directors are clearly identified and that functions are clearly delineated so that there is clarity as to the roles and responsibilities for differing aspects of administration and operation as between directors and officers.