Australian federal court finds in favour of former quintis CEO in directors duties case brought by regulator

The Australian Securities and Investments Commission (ASIC) has failed in its action against the former CEO & Managing Director of Quintis Limited (Quintis) for alleged breaches of section 180 of the Corporations Act (the duty to act with care and diligence). Following a four-week trial, the Federal Court of Australia ruled that Mr Frank Wilson did not breach his duty despite failing to disclose the termination of material customer contracts to the Quintis Board and the ASX.

The Court was of the opinion that ASIC had failed to prove its case, serving as a timely reminder that the onus is on ASIC to make out an action for an alleged breach of directors’ and officers’ duties and that absent detailed documentary evidence (including Board minutes), this can be an uphill battle.

Background

• Quintis (which de-listed in August 2019) was a supplier of sandalwood products.
• The Quintis Group entered into material supply agreements for sandalwood oil with Nestlé-owned dermatology company Galderma (Galderma Agreements). The Galderma Agreements were entered into by two of Quintis’ subsidiaries, ViroXis and Santalis. Galderma used the sandalwood oil in its Benzac acne product range.
• Mr Wilson was the largest shareholder in Quintis, had been a director since 2000, served as Executive Chairman from 2006 – 2011 and became Managing Director in September 2015.
• Dr Paul Castella was the founder of ViroXis and following Quintis’ acquisition of ViroXis and Santalis, served as CEO and President of ViroXis and Santalis.
• The Galderma Agreements allowed Galderma to terminate the contracts by giving two years' written notice. However, Galderma insisted that the two years' notice period be waived.
• Dr Castella claimed that he told Mr Wilson about the termination of the Gladerma Agreements. Mr Wilson disputed this and claimed that he was unaware that the contracts had been terminated.

Timeline

The below timeline sets out some of the key facts consider by the Court.

Issues

Notwithstanding the fact that Galderma entered into termination agreements with Santalis and ViroXis in December 2016, the key issues related to what Mr Wilson knew about the termination of the Galderma Agreements, and what steps he had taken to make the Quintis Board aware of this information.

ASIC alleged that from at least mid-2016 to December 2016 Mr Wilson was aware, or ought to have been aware, of Galderma’s intention to terminate the Galderma Agreements. ASIC alleged that, at the very latest, Mr Wilson knew that the Galderma Agreements had been terminated by February 2017 when Dr Castella claimed he gave Mr Wilson a copy of the termination agreements.

Among ASIC’s claims against Mr Wilson were allegations that:

• he failed to tell the board of directors of Quintis that the Galderma Agreements were at risk of being terminated, and then that they had been terminated, and that the Board thereby lost the opportunity to determine whether, in order to comply with its continuous disclosure obligations, it needed to inform the market of those matters in a timely manner. However, ASIC did not plead that Quintis did, in fact, breach its continuous disclosure obligations; and
• he failed to ensure that Quintis did not make statements to the market about the termination of the Galderma Agreements that were “potentially” misleading or deceptive (that is, he allowed Quintis to make its ASX announcement on 27 March 2017 listing Galderma as a material client). Again, it was expressly not part of ASIC's case that the relevant statements made by Quintis were misleading or deceptive (or likely to mislead or deceive) in contravention of s 1041H of the Corporations Act.

There was no associated claim that Quintis itself was in breach, and instead ASIC relied on a potential breach of the law by the company as evidence of Mr Wilson’s breach of his duties. This approach, which the Court accepted was permissible, is an example of the ‘stepping stone’ approach to director liability.

Findings

The Court found that ASIC had not established a breach of section 180 on the following three bases:

• A failure to establish that a reasonable director with knowledge of the potential termination of the Galderma Agreements would have informed the Board, when it wasn’t established that there was anything that the Board could have done to prevent the termination or to minimise harm.
• A failure to establish Mr Wilson’s actual knowledge of the termination of the Galderma Agreements in accordance with ASIC’s pleaded timeline of events. The frequency of communication between Mr Wilson and Dr Castella (his key management contact at Santalis in relation to Galderma) was considered a reasonable basis for Mr Wilson to form the assumption that Dr Castella would make Mr Wilson aware of any significant updates related to the Galderma Agreements. Despite this, ASIC failed to establish the method, date, and time that Mr Wilson became aware that the material contracts had been terminated.
• A failure to establish that Mr Wilson should have enquired further into management’s actions.

At one point in the judgment, Jackson J noted that he “found both Dr Castella and Mr Wilson to be unsatisfactory witnesses” and he was “not prepared to accept the truth of any of their evidence”.

Stepping stone liability

The Court (Jackson J) considered whether it was open to ASIC to bring a case against a director (i.e. proving a contravention of section 180) due to a potential breach of the law by the company, without ASIC pleading and proving that the breach by the company actually occurred. While this has been considered in other cases, the Court spent considerable time confirming this approach was acceptable.

The Court noted that section 180 does not stipulate that the company has suffered actual loss or damage in order for section 180 to have been breached, let alone that the company has been led into actual contravention of any law by reason of the director's conduct. What it does require is a foreseeable risk of harm. A risk of suffering penalties for breaching the law is a risk of harm. And “harm is properly understood more broadly than that as including harm to intangible interests of the corporation, such as its reputation. A risk that a company will be found to have broken the law or, conceivably, a risk that it will be perceived to have broken it, is a risk of harm, so understood. A company may run a risk of such tangible and intangible harms whether or not it is ever actually found to have contravened any law”.

However, whilst finding that it was open to ASIC to plead such a case, Jackson J also expressed some concerns as to such an approach. Jackson J observed that it may be that ASIC chose to avoid the need to prove that Quintis had breached the law because it thought that this would make its case easier, but that “any such choice would be problematic” and created “conceptual difficulties”. For instance, the Court noted that “by setting the bar for itself lower than proof of an actual breach [by the company], ASIC has made it easier to prove that Mr Wilson breached s 180. Even so, whatever ASIC has thus gained is then lost by the need to assess, not just whether Mr Wilson has breached his duties under s 180, but also the consequences of the breach”. Those consequences are relevant first in determining whether the breach of s 180 was serious or materially prejudicial (so as to meet the criteria for civil penalties imposed by s 1317G) and secondly in determining penalty.

Ultimately, Jackson J did not need to grapple with these complexities, because his Honour held on the facts that ASIC’s claims against Mr Wilson failed.

Key takeaways

On 5 September 2023, Jackson J dismissed the proceedings, indicating that ASIC has decided not to appeal. Please reach out to your HSF contact with any questions or comments as we continue to work through the impact of this decision.