Directors' Duties – Raising the Bar?

by Harvey Bowlt - September 2011

The recent case of ASIC v Healey & Ors [2011] FCA 717 (Centro Case) has highlighted the duties of directors of listed public companies in relation to the companies’ financial statements. 

ASIC instituted proceedings against the directors and financial officers of the Centro Group on the basis that they had failed to take all reasonable steps to comply with the companies’ financial reporting obli-gations in terms of the Corporations Act and had breached certain other statutory duties of care and diligence. In brief, the allegations by ASIC related to the incorrect classification of substantial liabilities of about AU$2 billion in the 2007 annual report as non-current liabilities and a failure to disclose substantial post balance date guarantee liabilities in the financial statements. 

The Federal Court ultimately found that the defendants had not been dishonest in carrying out their responsibilities, but found that they had ‘failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires’. 

ASIC sought orders disqualifying the directors for periods from six months to three years, as well as pecuniary penalties between $30,000 and $100,000. The Court recently ordered the former CEO, Thomas Scott, to pay a penalty of $30,000 plus a share of the legal costs and the CEO, Romano Nenna, to be disqualified as a director for two years, from 10 October 2011. The Court decided not to disqualify or fine the non-executive directors. 

Significance of the judgement 

Arguably, a director’s duty of care requirements are now more significant and include: 
 
  • applying their own minds to and carrying out a careful review of the proposed financial statements; 
  • considering whether the information in financial reports is consistent with the director’s knowledge of the company affairs and does not omit material matters; 
  • having sufficient knowledge about conventional accounting practice in order to carry out duties adequately; and 
  • making appropriate enquiries if they are uncertain.

 

Reliance on advice by others 

The Court found that: 
 
  • There is a core, irreducible requirement for directors to take all reasonable steps to be in a position to guide and monitor the company. 
  • Directors must approach their tasks with an ‘inquiring mind’. 
  • Directors require a level of scrutiny that is more akin to supervision, rather than detailed direct in-volvement in operational matters. 
  • Directors may rely on advice without independently verifying the information on which the advice is based, provided there is no cause for suspicion or circumstances demanding critical and detailed attention. Directors cannot rely on advice and management as a substitute for examination of im-portant matters falling within the board’s responsibilities.

The Court held that the errors were so obvious that the directors were negligent and this ‘Blind Freddy’ proposition occurred because the directors relied exclusively on the internal financial processes in place and on their advisers. In short, they should have looked at and considered the financial state-ments for themselves. 


What level of financial literacy is required? 

The Judge emphasised that the directors knew or ought to have known the effect of various accounting notes, enabling them to ascertain that the liabilities in question were current and should have been classified as such. Directors do not require intimate knowledge or understanding of accounting stan-dards, but merely need to read the accounting notes to be informed of the test that was to be applied. 

How to manage the information overload 

The Court was not sympathetic with the directors’ argument that they could not be expected to carefully check Board packs which varied between 450 and 1000 pages each month. The Judge indicated that they could control the information they received and directors who do not read, understand and focus on all the information provided to them are at risk of breaching their duty of care and diligence. 

Summary 

This case deals with a fairly discrete area of law, namely directors’ duties in relation to financial statements for large listed public companies. Accordingly, it remains to be seen to what extent such duties will be imposed on smaller private companies. However, the provisions of the Corporations Act are clear and directors and other officers need to exercise care and diligence in ensuring that they comply with their financial reporting duties. 
 

Harvey Bowlt

Senior Commercial Lawyer                                                                                    

Accredited Specialist - Business Law 

 


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