Earlier this month, the High Court of Australia found the directors of James Hardie Industries Ltd ("James Hardie") in breach of their duty of care by failing to prevent the company from making false or misleading statements to the market.1
The James Hardie decision adds to a recent line of cases from both New Zealand and Australia concerning the extent of directors' duties in relation to the approval of disclosures to the market.2 These well-publicised cases have not imposed any higher standards on directors than would commonly be expected, but do highlight some important lessons for directors in relation to disclosure obligations, reliance on management and third party advisers, and general standards of competency.
The James Hardie group of companies had been involved in the manufacture and sale of products containing asbestos. The subsidiaries responsible for the distribution of these products were subject to claims for damages for personal injury. In response, the board of James Hardie elected to separate the relevant subsidiaries from the rest of the group, and create the Medical Research and Compensation Foundation ("Foundation") to manage and pay out asbestos claims made against the subsidiaries.
On 15 February 2001, the board of James Hardie approved a draft ASX announcement containing statements to the effect that the Foundation was "fully-funded" and would have "sufficient funds to meet all legitimate compensation claims". It was subsequently discovered that the Foundation was underfunded by over A$1 billion. The Australian Securities and Investments Commission ("ASIC") accordingly commenced proceedings against the directors and officers of James Hardie.
The Courts' findings
At first instance, the Court found the directors of James Hardie in breach of their duty of care3 by failing to prevent the company from making false or misleading statements to the market. The five directors who were physically present at the 15 February board meeting breached this duty by assenting to the resolution approving the misleading announcement. The two other directors, who were participating in the meeting by telephone, breached this duty by failing either to request a copy of the announcement or to abstain from voting in favour of the resolution.
Additionally, the James Hardie general counsel and company secretary was found to have breached his duty of care4 by failing to advise the board that: the draft announcement was expressed in overly emphatic terms; the advice from external parties5 was limited and based on unverified assumptions; and the announcement was insufficiently detailed in relation to the indemnity arrangement between the liable subsidiaries and James Hardie.
The Court of Appeal overturned the original findings after consideration of evidentiary issues, finding that ASIC had failed to establish that the draft announcement had been tabled at the relevant board meeting and that the draft had been approved by the directors. This finding was eventually reversed by the High Court6, but the conflicting results here highlight the need for good corporate governance in the manner in which resolutions are proposed, approved and recorded.
Lessons for directors and officers from the James Hardie decisions
- The board of directors is responsible for ensuring it has obtained all the information necessary from management in order to make an informed decision. The directors of James Hardie had not been presented with sufficient information to reach the conclusion that the Foundation was fully funded, yet they approved a resolution implying that they had. This failure was highlighted by the minutes of the board meeting immediately preceding the meeting of 15 February, where direction was given to management to continue to develop the Foundation concept, "particularly in regards to funding". Directors need to show proactive, inquiring minds, and be confident that the material available to them provides a reasonable basis for the resolutions they approve.
- While directors are entitled to rely on information from management and advice from external third parties, it is the responsibility of each director to review, understand and formulate an opinion on the sufficiency of such information for providing a basis for the approval of a resolution.
- A failure of management to provide the board of directors with sufficient information to vote on a resolution does not free directors from the final responsibility for approval of a resolution. The general counsel and company secretary of James Hardie was held to have breached his duty of care by omitting to advise the board both in relation to the overly emphatic drafting of the announcement and the incompleteness of external consultation relating to the adequacy of the Foundation's funding. It is important to note, however, that this breach occurred under section 180(1) of the Australian Corporations Act 2001, which extends a duty of care to officers as well as directors of a company. New Zealand imposes no equivalent statutory duty on officers.
- The board of directors needs to be familiar with all material circulated at a meeting of directors. Two of the James Hardie directors were found in breach of their duties as a consequence of approving the announcement via teleconference without a copy of the announcement in front of them. Where board meetings are conducted remotely, all participating directors need to be in possession of the same material.
- It is good corporate governance to formally propose each resolution at a board meeting, and ascertain each director's position on the resolution. Additionally, a complete set of documents that is provided to the board of directors prior to a meeting should be maintained by the company as evidence of what has been tabled and considered. Finally, review and approval of minutes by the board can add a further layer of certainty to a resolution. These steps are important in the relatively common circumstance where the results of a particular board meeting become relevant a long period after its occurrence, as in the James Hardie cases.
For a full discussion of the other recent decisions in relation to directors' duties, please refer to earlier corporate advisory alerts available at http://www.russellmcveagh.com/_docs/CorporateAlertJul2011_408.html and http://www.russellmcveagh.com/_docs/CorporateLitigationAlertMarch2012_452.html.