The recent New South Wales Supreme Court decision of Australian Securities and Investments Commission (ASIC) v Macdonald (No 11)  NSWSC 287 (commonly referred to as the James Hardie decision) serves as a dramatic reminder of the importance of directors' duties in the operation of a board of directors.
The heart of the allegations made by ASIC was that James Hardie Industries Limited (JHIL), three company executives and seven non-executive directors made or approved misleading and deceptive statements in various company announcements, by saying that James Hardie's Medical Research and Compensation Foundation (Foundation) was fully funded, offering certainty for asbestos victims. The reality was that it was not possible to state with any certainty that the Foundation was fully funded, as the valuation of future asbestos claims was based on key assumptions that were inherently uncertain. In fact, it now appears that the Foundation was underfunded by more than $1 billion.
Justice Gzell found that the directors of JHIL breached their duties to the company in approving the provision to the Australian Securities Exchange (ASX) of a draft announcement that stated unequivocally that the Foundation would have sufficient funds to meet all legitimate asbestos related compensation claims. The false and misleading statements made by JHIL to the ASX and in investor briefings were based on the company's cash flow models and reports of Trowbridge Deloitte Ltd. While the cash flow models had been reviewed by PriceWaterhouseCoopers and Access Economics for logical soundness and technical correctness, neither of them reviewed the assumptions underlying the models. The Trowbridge report likewise contained significant limitations, uncertainties and qualifications. In focussing on the absolute nature of the statements made by JHIL, Justice Gzell noted that the statements should have been qualified, given the limited review and assumptions and limitations set out in the cash flow models and expert's reports.
His Honour also found that the company had breached its continuous disclosure obligations by failing to disclose the arrangements made between JHIL and two of its former subsidiaries, including a deed of covenant and indemnity between JHIL and the two former subsidiaries (DOCI). Under the DOCI, the two former subsidiaries (the shares in which had been transferred to the Foundation) indemnified JHIL against future asbestos claims and took responsibility for administering future asbestos-related payments. In return, JHIL promised to make various payments (with a net present value of $73.4 million) over 42 years to the two former subsidiaries.
Allegations against the general counsel
Peter James Shafron fulfilled the roles of general counsel and company secretary of JHIL, a dual role which is not unusual within Australian public companies. ASIC alleged that Mr Shafron was an "officer" of JHIL under the definition in section 9 of the Corporations Act 2001 (Cth) (Corporations Act), and accordingly that he owed a duty of care and diligence to the company under section 180(1) of the Corporations Act.
A secretary of a company is automatically considered to be an officer under section 9. Justice Gzell did not rely on the fact that Mr Shafron was company secretary, however, in finding him to be an officer of JHIL. Instead, the court considered both the nature of the role of general counsel generally and the particular responsibilities that Mr Shafron undertook in performing the role. For example, Mr Shafron attended and presented at board meetings, retained Trowbridge on behalf of JHIL, and assisted the company's CEO in drafting board papers and planning and implementing the various proposals the subject of the ASX announcement.
The court concluded that "the functions performed by Mr Shafron involved him participating in the making of decisions that affected the whole or substantial part of the business of JHIL", and accordingly that he was an officer of the company. While the court's conclusion turned on an assessment of Mr Shafron's particular responsibilities, those responsibilities are not unusual for general counsels today. As a result, a prudent and "best practice" approach would be for general counsel to assume that the duties set out in Part 2D.1 of the Corporations Act will apply to them.
Directors' and officers' duty under section 180(1)
Section 180(1) of the Corporations Act confers an obligation on the directors and officers of a company to exercise their responsibilities with care and diligence. Justice Gzell held that guarding JHIL against legal risks was a core responsibility of Mr Shafron as general counsel. In the particular circumstances of this case, this included a duty to:
- protect JHIL against the legal risks associated with making a false and misleading ASX announcement; and
- advise or obtain advice for the board as to whether the terms of the DOCI were required to be disclosed in order to comply with JHIL's continuous disclosure obligations.
An argument was made that it should have been obvious to JHIL's directors that the ASX announcement was false and misleading, and that the terms of the DOCI were material and price sensitive, and that as a result Mr Shafron did not have any duty to point this out to the board. The court disagreed, finding that notwithstanding what the directors should reasonably have known, Mr Shafron had a duty to warn the directors that the ASX announcement was too emphatic, and to ensure that the directors were properly advised of the continuous disclosure implications of the DOCI.
It is clear from this decision that general counsel, in assessing the exposure of their companies to legal risks, have an affirmative duty to bring significant legal risks to the attention of the company and its board of directors, even where those risks may fairly be considered to be self-evident.
Practical implications for general counsel
Whilst the James Hardie decision should be read in light of its unique facts, and may still be subject to review by the appellate courts, it certainly presents general counsel with a number of salient reminders in relation to their role and the legal duties stemming from it. In particular:
- General counsel should be conscious that they are likely to be considered to be "officers" under the Corporations Act. Officers, like directors, have specific duties under Part 2D.1 of the Corporations Act. In particular, section 280 conveys upon general counsel the obligation to fulfil his or her duties (such as to advise on legal risk) with due care and diligence. It is worth noting that the court in the James Hardie decision also suggested that a general counsel's duty may extend to protecting the company against harm to the company's reputation.
- General counsel should be reminded that their obligations are ultimately owed to the board, and not merely to the company's chief executive officer or managing director. Informing the CEO or managing director of a particular risk may not relieve the general counsel of his or her duty also to advise the board appropriately (particularly where the general counsel attends board meetings).
- Formal reporting lines should be implemented to ensure a general counsel's advice is provided effectively to the board. This will assist general counsel in managing their personal liability and will also ensure that important advice is received at the right level.
- The provision of advice and guidance to the board in relation to a disclosing entity's continuous disclosure obligations under the Corporations Act and, if applicable, the listing rules of the relevant financial market, are within the scope of general counsel's duties. The fact that the disclosure requirements may be regarded as being 'common knowledge' is unlikely to absolve general counsel of this duty.
- In addition, a general counsel has a duty to provide advice on the legal risks of material statements made in public announcements, including by ensuring that the board is aware of any material limitations or qualifications in any reports or other materials on which those statements are based, and that the statements are appropriately balanced.
- In light of the risks associated with their role, general counsel should take steps to limit their exposure to personal liability by reviewing the terms of any existing deed of indemnity between themselves and the company. If no such indemnity arrangements exist, it would be prudent to speak with the CEO or managing director about entering into such a deed. We note, however, that section 199A of the Corporations Act limits the extent to which officers can be indemnified by a company for liabilities incurred as officers of the company.
Since this article was initially published, Justice Gzell has handed down penalties to each of the James Hardie officers who were the subject of these proceedings. Of particular significance to this article, Mr Shafron was fined $75,000 and disqualified from managing corporations for seven years.