Companies and Securities Law: Analysis of Middleton Js Reasoning in ASIC V Healey - Research Paper Example

Research Assignment for Companies and Securities Law 1. Evaluate and analyze Middleton J’s reasoning in ASIC V Healey In ASIC V Healey &Ors, Justice Middleton of the Federal Court of Australia held that the error in the financial statements should have been noticed by the company’s directors. He also noted that none of the directors had been ignorant of the liabilities and guarantees of the company (ASIC v Healey & Ors , 2011). As such these directors were precluded from contending that they had not been aware of the errors in the proposed financial statements of the company. The directors of the Centro group of companies were presented with the financial reports of this group for the year 2007. There were glaring irregularities in these reports. For instance, the financial report of one group, namely the Centro Properties Group had concealed the true extent of its short term liabilities, by classifying them as non – current liabilities. This malpractice served to falsely classify assets to the tune of $1.5 billion. Moreover, the report of another group failed to disclose short term liability guarantees to the extent of $1.75 billion. Furthermore, yet another group falsely classified $500 million of short term liabilities as non – current liabilities. The directors affixed their signature to these reports, without attaching any importance to these gross deviations in financial reporting. The Australian Securities and Investments Commission (ASIC) initiated proceedings against these directors for infringement of sections 180(1), 344(1) and 601 FD (3) of the Corporations Act 2001. It was contended by the ASIC that these directors had breached their duty under section 180(1), which requires a director to exercise the same level of diligence and care that could be expected of a reasonable person who happened to be a director of a similar corporation and who was assigned with the same level of responsibility in that organisation as the director. However, it was opined by Middleton J that each and every one of the company directors had neglected to peruse the financial statements, especially with regard to short term debt. It was also stated by the judge that these directors had not considered the importance of not disclosing the guarantees, and that they had failed to enquire of the management, and the audit committee of the board of directors, in this context. Furthermore, these directors had not bothered to ensure the correction of the errors detected and had not obtained the declarations that should have been provided to them under section 295 A of the Corporations Act 2001 (ASIC v Healey & Ors , 2011). As such, it was held by Middleton J that the defendant directors had breached their duty of care and diligence that they owed to the Centro entities. This constitutes a violation of sections 180(1) and 601FD (3) of the Corporation Act 2001. Moreover, they had breached section 344 of this act by failing to implement reasonable measures to enforce compliance with the financial reporting requirements, stipulated in this act (ASIC v Healey & Ors , 2011). These omissions in the financial statements of the company were not technical oversights, in the opinion of the judge. The latter held that the financial statements had not been examined with the necessary care and diligence by the directors. Moreover, this judge opined that the issues not disclosed in these financial statements were either familiar to the directors or were matters that should have been well known to them. Therefore, these directors should not have certified the fairness and truthfulness of the financial statements. In addition, they should not have published the annual reports without a disclosure of these important matters. Middleton J’s ruling in this case, brings home the fact that directors cannot adopt a carefree attitude to crucial features. For instance, directors have to possess the necessary financial information to understand financial statements. In addition, they have to exercise proper diligence whilst perusing such statements. It is not advisable for directors to blindly rely on the company’s auditors or management. Each and every director has to read, comprehend and concentrate upon any document that has to be approved by them. In addition, they have to diligently apply the knowledge that they possess, by virtue of being the company’s directors (Centro Decision on Directors’ Duties , 2011). 2. Explain the ramifications for Directors and Companies and any criticism of the judgment, Middleton J’s ruling in this case, provides an indispensable discussion regarding the legal norms that apply to the process of civil penalty and disqualification of company directors who furnish company financial statements that contain omissions and inaccuracies. Subsequent to the ruling in this case, it has been anticipated that corporate accounts will be subjected to greater scrutiny. In addition, the Regulator is expected to play a more active role, in cases involving errors in financial statements. Furthermore, there is every possibility of enhancement in civil penalty prosecutions, in this area (O'Brien, Paul, 2011). Hence, the directors of company will be required to be more attentive towards their duties, especially those related to the accounts of the company, as they will be held accountable for errors of omission and commission in the financial statements of the company. The decision in the ASIC case indicates that the directors of a company have to acquire financial literacy about the company’s financial affairs. Such familiarity has to be to the extent necessary to understand the statements. The directors of a company have the power to delegate responsibility to others. All the same, the court ruled in this case that such reliance had to be to a limited extent, with regard to financial statements. It was made very clear by the court that the ultimate responsibility for approving financial statements was vested with the board of directors. (Corporate update. ASIC v Healey: The Centro decision , 2011). In addition, it was held that such responsibility did not admit of delegation to others. With the decision in ASIC v Healey, it became obvious that the directors of a company had to acquire a degree of familiarity with financial statements. Thus, directors cannot rely on the statements of others, while affixing their signature to such statements. Although, directors need not be experts in accounting, all the same they have to ensure that the company’s financial statements reflect the true position of the company (Director insights. Board and audit committee update on directors’ duties — the impact of the Centro case , 2011). The actual preparation of financial statements and maintenance of the books of accounts of the company is not the task of the directors. The latter can and do delegate such work to others. Furthermore, the day to day affairs of the company have to be conducted by the persons to whom the necessary powers, in this context, have been delegated. The task of the directors is to bestow intelligent and diligent interest upon the information available to them. Moreover, they are required to comprehend such information and address it with an enquiring mind (Corporate update. ASIC v Healey: The Centro decision , 2011). Moreover, they are required to comprehend such information and address it with an enquiring mind. As such, this case makes the duty of care and skill of Directors, more burdensome. 3. Compare the Courts view with that in Re City Equitable Fire Insurance Ltd [1925] In Re City Equitable Fire Insurance Ltd, the court held that the true financial position of the company was to be depicted in the financial statements that were presented to the members by the company’s auditors. It was also held that it was insufficient, if the auditors merely provided a reference to the sources of financial information (Re City Equitable Fire Insurance Co , 1925). Business is inherently risky in nature, and this explains the reluctance of the courts to interfere with the functioning of the company’s board or anticipate what a director should decide. Until and unless a director’s decision is grossly negligent or abjectly imprudent, the courts do not intervene. The interference of the courts can be ensured, as long as the company’s directors discharge their duties without promoting their personal interests. (Hooper, 2011). Every bad decision of the directors does not attract action for negligence, unless it is truly unpardonable, and this constitutes the business judgement principle. It had been the practice to view company directors’ duty of care and skill in a manner that would place a minimal burden upon them. Thus, in Re City Equitable Fire Insurance Company Ltd, the management director was convicted for fraud, when serious deficit of funds was detected. An attempt was made by the liquidator to fix liability upon the other directors for not detecting the fraud (Bourne, 2004, p. 218). In his judgement Romer J came up with three proposals regarding the duty of care and skill. First, it not necessary for a director to employ greater skill, during the discharge of his duties, than might be expected of a professional with the same level of experience and knowledge. Second, there is no necessity for a director to bestow continuous attention upon company affairs. The duties of a director enjoy an intermittent quality, and come into play, chiefly during board meetings. In addition, the director is not obliged to attend each and every board meeting. However, a director is expected to be present in a board meeting, when it is possible for him to do so, from a reasonable point of view. Third, a director of a company can trust an official of the company, provided there no grounds for suspicion, to perform the duties that fall under the purview of that official (Bourne, 2004, p. 218). Subsequently, the duty of care and skill has commenced to undergo change. Thus, section 214 of the Insolvency Act 1986, incorporates a standard of care that the directors of an insolvent company should have exercised (Company Law Reform Bill [HL], 2005). This provision has been employed in several instances to prove the existence of an objective standard of care. For instance, in Norman v Theodore Goddard, the court ruled that this standard was applicable to a company director, who had behaved in a reasonable manner while accepting information provided by a senior partner in the defendant firm (Bourne, 2004, p. 218). Furthermore, in Re D’Jan of London Ltd, the court held that the pertinent duty of care in the context of disqualification proceedings was stipulated under section 214 of the Insolvency Act 1986. In this instance, the director in question had accepted an insurance proposal, without examining its contents. Subsequently, the premises of the company, which had been insured in this insurance policy, were destroyed in a fire, and the insurance company refused to honour the claim. The reason provided for this refusal was that the information was incorrect (Bourne, 2004, p. 218). The court held the director to be negligent in his duty of care towards the company. However, in ASIC v Healey and others, while holding the directors guilty of dereliction of their directorial duties, Middleton J declared that it was incumbent upon the former to carefully and diligently peruse the financial statements of the corporation. In addition, directors could not evade accountability by contending that they had relied upon what the management or auditors had informed them. It was essential for the directors to verify the financial statements provided to them. Although Middleton J did not find dishonest behaviour among the directors, he roundly condemned them for failure to apply their minds, which had resulted in the failure to detect these glaring mistakes (Corporate & Commercial Insights, 2011). This decision requires directors to examine financial statements with great care. In Re City Equitable Fire Insurance Ltd, a minimal burden of care was placed upon the directors by making the auditors responsible for the financial statements provided by them to the board of directors. Consequently, these personnel were required to perform their accounting tasks with utmost faith and responsibility. As such, in this case, it was held that directors had to exercise the same level of care and skill as exhibited by any professional with the same experience and knowledge. In addition, no greater care or diligence than what is expected of a professional with the same experience and knowledge is expected from a director. This state of affairs was significantly changed with the decision in ASIC v Haley, where a much greater responsibility was placed upon the directors of the company. In essence, the court held that directors could not merely rely on the financial statements provided to them by the audit committee. 4. Two other recent cases that are referred to in the judgment that reflect on Directors duties There is considerable difficulty associated with the interpretation of the business judgement rule, as was realised in the Australian context. This came to the fore with the ruling in ASIC v Rich (Australian Securities and Investments Commission v Rich , 2009) and the discussion paper dealing with insolvent trading and directors’ duties that was released by the Australian Federal Government (Hooper, 2011). In the ASIC v Rich (Australian Securities and Investments Commission v Rich , 2009) case it was observed that section 180(1) and section 180(2)(d) of the Corporations Act 2001are not mutually exclusive. This was noticed while debating over the connotation of the term ‘rationally believe’. In particular, section 180(1) addresses the explicit standard of care and diligence that directors should exercise while utilising their powers. On the other hand, section 180(2)(d) relates to the quality of what a director considers to be the best interests of the company (Hooper, 2011). It is to be clearly understood that section 180(2) protects a director who arrives at a business judgement that a director exercising reasonable care would avoid. However, such a director should have believed on rational grounds that his course of action was the best under the circumstances and that it would promote the best interests of the company. This makes a strong case for accepting the literal meaning of the phrase rational belief or what can be termed a Wednesbury (Associated Provincial Picture Houses v Wednesbury Corporation , 1948) approach. A director’s conduct cannot be excused, under each and every circumstance, on the grounds of ignorance. For instance, in Hudson Investments Group Ltd v Australian Hardboards Ltd, it was established that two of the directors had violated their fiduciary duties. This had transpired when these directors had shown partiality towards a particular company in the group, with respect to a share purchase agreement that was to take place in the future (Wong, 2009). These directors sought discretionary relief, which the court refused to grant. With regard to one of the directors, namely McLeod, the court held that his crucial position in the deal and his state of mind precluded the grant of any such relief. On the other hand, the second director, Holland contended that he had merely acted at the behest of McLeod and that he was not aware of the details of the deal. The court did not accept this argument and held that as a director of a public limited company, Holland was required to bestow his attention upon what he did in his capacity as a director. The court ruled that Holland had been negligent in his duties, as he had blindly followed the direction given to him by McLeod (Wong, 2009). As such, the court was of the opinion that Holland had indulged in an act of wilful blindness. Consequently, his ignorance of the deal was deemed to be unreasonable. This decision makes it essential for senior directors of large corporations to be vigilant in their activities. Such directors do not delve into the day to day affairs of the company, which is the preserve of the management. Nevertheless, the extant case law makes it imperative for these directors to obtain a familiarity with the circumstances regarding issues that they were expected to have knowledge about. This state of affairs results in considerable tension between the role of the senior management and the board of directors, in large corporations. List of References Australian Securities and Investments Commission v Rich , 75 ACSR 1 (2009). ASIC v Healey & Ors (2011). Associated Provincial Picture Houses v Wednesbury Corporation , 1 KB 223 (1948). Bourne, N. (2004). Directors – duty of care and skill. Business Law Review, pp. 218 – 219. Centro Decision on Directors’ Duties . (2011, June 30). Retrieved September 6, 2011, from http://www.rk.com.au/uploads/file/Centro%20Decision%20-%2030%20Jun%202011.pdf Chan, S. (2009, April). Directors’ duties in Hong Kong: Codify or Not? Retrieved September 12, 2011, from http://www.hkiaat.org/images/uploads/articles/Director.pdf Company Law Reform Bill [HL]. (2005, November 17). Retrieved September 15, 2011, from Parliament UK. House of Lords: http://www.publications.parliament.uk/pa/ld200506/ldbills/034/en/06034x-e.htm Corporations Act 2001. Act No. 50 of 2001. An Act to make provision in relation to corporations, securities, the futures industry and financial products and services, and for other purposes. (2001). Office of Legislative Drafting and Publishing, Attorney – General's Department, Canberra. Corporate & Commercial Insights. (2011, July). Retrieved September 6, 2011, from http://www.rk.com.au/uploads/file/C&C%20Insights%20-%20July%202011.pdf Corporate update. ASIC v Healey: The Centro decision . (2011, August). Retrieved September 14, 2011, from http://www.jacmac.com.au/%5Ccontentversion%5C-761259718%5Cdocs%5CCorporate_Update_-_ASIC_v_Healey_The_Centro_decision.pdf Director insights. Board and audit committee update on directors’ duties — the impact of the Centro case . (2011, July). Retrieved September 14, 2011, from http://www.ey.com/Publication/vwLUAssets/Director_Insights_0711/$FILE/Director_Insights_0711_FINAL.pdf Hooper, M. (2011). The Business Judgment Rule: ASIC v Rich and the reasonable-rational divide. Retrieved September 11, 2011, from Bond University: http://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1021&context=cgej Hudson Investments Group Ltd v Australian Hardboards Ltd, NSWSC 716 (2005). Insolvency Act (c.45). (1986). UK: © Crown copyright. Norman v Theodore Goddard , BCLC 1028 (1991). O' Brien, P. (2011, July). Case note: ASIC v Healey. Retrieved September 6, 2011, from http://www.ypol.com.au/pdfs/Case%20note.%20ASIC%20v%20Healey%20(00186034).pdf Re City Equitable Fire Insurance Co (1925). Re City Equitable Fire Insurance Company Ltd , 1 Ch 407 (1925). Re D'Jan of London Ltd , BCC 646 (1993). Wong, S. (2009). Forgiving a Director’s Breach of Duty: A review of recent decisions. Retrieved September 14, 2011, from http://cclsr.law.unimelb.edu.au/files/stevenwong_essay_6_May_20091.pdf Read More