Reform kites are being flown on directors' liability reform
Nov 2014 |Introduction
Under the Corporations Act 2001 (Cth) (Act), company directors have a defence to counter claims of negligence against them if they can satisfy the criteria in the ‘business judgment rule’ (subsection 180(2)).
The Australian Institute of Company Directors (AICD) and respected commentator, former NSW Supreme Court Judge, Dr Robert Austin, have been vocal in their calls for legislative reform to reduce liability exposure for directors beyond negligence.
The purpose of this article is to provide an overview of the position, given that the debate on this topic has been dragging for some time. Conversely, shareholder lobby groups have been down playing the need for reform.
An explanation of the business judgment rule
The business judgment rule (s 180(2)) currently provides a defence to claims made against a director based on negligence, i.e. failing to exercise the expected degree of care and diligence. There are four criteria that need to be satisfied:
- The director needs to have made the relevant decision in good faith and for a proper purpose.
- The director is not to have a material personal interest in the subject matter of the decision.
- The director is to have been reasonably and appropriately informed about the subject matter of the decision.
- The director needs to believe that the decision made is in the best interests of the corporation and is a rational decision, based on the reasonable person test.
The defence is specific only to negligence claims – it does not operate as a defence to any other claims relating to breaches of directors’ duties. Many directors are concerned about their exposure to negligence claims after the event. The fear of being sued (rather than the merits of litigation) are continuing (according to the AICD) to make directors less entrepreneurial and more risk averse.
The AICD proposal
The AICD wants a universal defence available to directors if they act or fail to act, for a proper purpose, rationally, and with reasonable care, diligence and honesty. The full text of the AICD reform section, by way of a new insertion into the Act is as follows:
‘Notwithstanding any other provision of this Act or the ASIC Act, if a director acts (or does not act) and does so honestly, for a proper purpose and with the degree of care and diligence that the director rationally believes to be reasonable in all the circumstances, then the director will not be liable under or in connection with any provision (including any strict liability offence) of the Corporations Act or the ASIC Act (or any equivalent grounds of liability in common law or in equity) applying to the director in his or her capacity as a director.’
Critique of the AICD proposal
At the macro level, it can be argued that the Act was never intended to have so much levity. There is some evident friction with the AICD proposal and the legislative intention to hold directors accountable for their actions. The Senate Standing Committee on Legal and Constitution Affairs made this comment (1989) on its understanding of the purposes of having directors’ duties:
‘to protect people (such as shareholders) who entrust their interests to the care of others (such as directors). It does this…by imposing standards of conduct the breach of which will always give rise to liability.’
Later, the Parliamentary Joint Committee on Corporate and Social Responsibility made these comments on the purposes of having directors’ duties (2006) to:
‘allow investors to invest in a company on the understanding that the company directors will manage the company in the interests of shareholders. When a shareholder invests in a company, they are in one sense investing in the capacity of the directors and managers to operate the company.’
Primarily, the predominant abuse (historically) has been by directors misusing their powers.
The AICD proposal does not directly address these elements of the business judgment rule:
- The good faith element.
- The existence of any conflict of interest.
- Being appropriately informed.
- Acting in the best interests of the corporation.
Purists may try to argue that the satisfaction of these four factors is inherent in the concepts of honesty, for a proper purpose and the director’s consideration that his/her level of exercised care and diligence is reasonable. However, there is no doubt that the AICD proposal will be acceptable to the wider public.
The Austin proposal
Dr Austin has been attributed with a proposal protecting directors if they make decisions unless they were proved to be dishonest, conflicted or unreasonable. The thrust of this proposal is also to be recognised in all Commonwealth or State Acts that impose a duty or a penalty on a person. Without having seen more detail, it is hard to critique the proposal, other than to indicate deficiencies similar to the AICD proposal.
The current ‘balancing’ factor
There are two sections now in the Act intended to allow a person, such as a director, to escape penalty. Firstly,
s 1318 operates in civil proceedings involving negligence, default, breach of trust or breach of duty where the Court can relieve that person from the consequences of liability if the person proves they acted honestly, and that the circumstances demonstrated that the person should be fairly excused. Secondly, s 1317S operates to provide relief where a director or other person might be proven to have contravened a civil penalty provision. In that case, s 13175(2) enables the Court to order that the person be relieved of liability if the person acted honestly, and having regard to all the circumstances, the person ought to be fairly excused for the contravention.
Where to?
It is now official that the Commonwealth Attorney General, the Honourable George Brandis QC, has requested the Australian Law Reform Commission (ALRC) examine issues that will extend to corporate regulation of directors. On 31 July 2014, the AICD indicated that a number of politicians were being lobbied with the AICD proposal (including Mr Brandis), presumably to hasten the convening of the ALRC. Media reports of 31 July 2014 attributed the AICD as indicating that the directors of James Hardie and Centro may have not been subject to legal action if the AICD proposal had been in place.
The ALRC’s considerations on this topic will be widely awaited. However, the introduction of legislative reform will be the Government’s decision, not that of the ALRC, and the position of the minority in the Senate having the balance of power will create added interest.