In ASIC v Macdonald (No 12)  NSWSC 714, Justice Gzell of the New South Wales Supreme Court has imposed substantial periods of disqualification and pecuniary penalties on three former executives and seven former non-executive directors of the James Hardie Group (see Annexure A). The decision follows Justice Gzell’s April 2009 judgment that each had breached their statutory duty of care and diligence in connection with public statements about the adequacy of funding available to meet asbestos-related claims1.
The August 2009 decision serves as a reminder of the risks that face directors in discharging their duties. The judgment highlights the courts’ robust expectations about the level of examination and scrutiny required of directors, including non-executive directors, in monitoring the actions of management—particularly in relation to matters of strategic significance.
Although the factual circumstances of this case were unusual, boards should carefully consider the need to investigate or interrogate materials from management and other advisers across a range of situations, including matters of public disclosure.
Background to proceedings and allegations by ASIC
In April 2009, Justice Gzell held that James Hardie Industries Ltd (JHIL), three former executives and seven former non-executive directors had contravened Commonwealth corporations legislation in relation to public statements regarding the Medical Research and Compensation Foundation (Foundation). The Foundation had been established to meet asbestos claims against former James Hardie Group companies.
Justice Gzell found that statements to the effect that:
- the Foundation would have adequate funds to meet all future legitimate asbestos-related claims
- the establishment of the Foundation would provide certainty for people with legitimate claims against the James Hardie Group, and
- expert advice had been obtained concerning the level of funding required to meet future claims,
were false or misleading and the defendants had breached the statutory duty of care and diligence in section 180(1) of the Corporations Act in connection with the statements.
Liability attached to the former non-executive directors and the CEO for their approval of a draft ASX announcement at a meeting of the board of directors of JHIL on 15 February 2001 (Draft ASX Announcement - reproduced in Annexure B). Justice Gzell concluded that the information before the board did not support the emphatic language of the Draft ASX Announcement.
The task facing the directors was said to involve ‘no more than an understanding of the English language used in the document’2. Nevertheless, Justice Gzell also found that the former CEO, CFO and General Counsel had each breached section 180(1) by failing to advise the board in relation to:
- the use of overly emphatic language in the Draft ASX Announcement, and
- limitations affecting the external review of a cash flow model regarding the proposed level of funding to meet legitimate asbestos-related claims.
ASIC succeeded in proving allegations against the former CEO in respect of:
- approval of the final form announcement (reproduced in Annexure C)
- statements made during a press conference the same day
- two subsequent ASX releases about the adequacy of funding, and
- slides released to the ASX and statements made during a 2002 UK investor roadshow.
The court was satisfied the former CEO had acted dishonestly in relation to the ASX slides and roadshow statements in 2002.
ASIC succeeded in proving its allegations against JHIL, the former CEO and General Counsel concerning the company’s continuous disclosure obligations in relation to a deed of covenant and indemnity in favour of JHIL by former subsidiaries with potential liability for asbestos claims in February 2001.
Discretion to excuse liability for breach of duty
The Corporations Act allows the court to exonerate persons for breach of the civil penalty provisions, or for negligence, default, breach of trust or breach of duty3. The exoneration provisions confer a wide discretion on the court where it appears that the person:
- acted honestly when breaching the statutory duty, and
- ought fairly to be excused in all the circumstances of the case.
Justice Gzell refused exoneration applications by the former non-executive directors, the former CFO and the former General Counsel.
First limb – acted honestly
With the exception of the former CEO, ASIC did not allege that the defendants had acted dishonestly. Yet Justice Gzell considered that the absence of an allegation of dishonesty was alone insufficient to satisfy the first limb. This limb requires the court to be positively satisfied about the honesty of a defendant.
Lack of dishonesty, however, does not equate to a positive finding of ‘honesty’. The first limb may be satisfied where the person’s conduct exhibits:
- a lack of moral turpitude, or
- an absence of deceit, conscious impropriety or intent to gain improper benefit or advantage.
A person’s ‘carelessness or imprudence’ in discharging statutory duties and responsibilities might prevent the court from forming a positive view of honesty. This will be the case if the ‘carelessness or imprudence’ rises to a level which either:
- negates performance of the underlying duty, or
- demonstrates that no genuine attempt was made to carry out the duty.
A person’s carelessness might have been so high as to have been ‘dishonest’ or so low as to constitute a mere error of judgment falling short of dishonesty4. Difficult questions necessarily arise in characterising the quality of conduct falling between those two extremes.
Court not satisfied the non-executive directors acted honestly
Whilst accepting that the non-executive directors may have believed they were acting in the best interests of the James Hardie Group, Justice Gzell found that the board was prepared to allow JHIL to make unequivocal and unqualified statements about the sufficiency of funding in order to quell any opposition to the proposal to:
- establish the Foundation, and
- transfer former subsidiaries of JHIL from the James Hardie Group to the Foundation (separation proposal)5.
The separation proposal was a significant event in the life of JHIL. It had been the subject of previous board consideration. Justice Gzell considered that the non-executive directors were aware of the significance of the Draft ASX Announcement.
Justice Gzell held that, in voting in favour of the Draft ASX Announcement in circumstances where they subsequently stated that they would not have approved of the emphatic assertions of sufficiency of funding, the non-executive directors had acted in a manner inconsistent with a finding of honesty6.
Two of the non-executive directors who were physically present at the 15 February 2001 meeting did not give evidence at trial. They were found to have had copies of the Draft ASX Announcement available to them and to have failed to speak against the resolution to approve the draft. Justice Gzell was unable to reach a level of positive satisfaction that they had acted honestly in relation to the Draft ASX Announcement7.
Justice Gzell found that sufficient discussion of the Draft ASX Announcement had taken place during the board meeting to have alerted directors who did not have a draft of the announcement to the fact that the board was considering a document they did not possess. Their failure to ask for a copy, and silence knowing that it would be taken as a vote in favour of approval, was found to constitute no less serious a breach of duty than that of the other directors8.
Justice Gzell was not satisfied that the non-executive directors had acted honestly contravening section 180(1)9.
Second limb – ought fairly be excused in all the circumstances
Factors relevant to the second limb include:
- the extent to which the breaching conduct falls short of the statutory standard of care and diligence
- contrition, and
- seriousness of the contravention. This is assessed by reference to the following:
- importance of the public policy advanced by the statutory provision
- degree of flagrancy of the breach, and
- consequences of the breach in terms of harm caused to others10.
No excuse from liability in the circumstances
Justice Gzell found that, in endorsing a public announcement where they:
- had no sufficient support for the statement of sufficiency of funds, and
- knew or ought to have known the announcement would influence the market,
the non-executive directors committed a serious and flagrant breach of duty11.
In seeking to be excused from liability, reliance was placed on a range of potentially mitigatory circumstances surrounding the board’s approval of the Draft ASX Announcement:
- JHIL management and advisers (commercial and legal) were present at the 15 February 2001 board meeting and raised no concerns
- JHIL’s disclosure policy was not adhered to in that approval was sought for the Draft ASX Announcement without first obtaining line management and senior executive sign-off
- JHIL had received legal advice around the compatibility of directors’ duties and approval of the creation of the Foundation
- the board was provided with a cash flow model supporting the adequacy of the proposed level of funding but did not receive advice about the limitations of that financial model and of reviews of the model by external experts, and
- the isolated nature of the breaching conduct contrasted with each of the defendants’ long periods of competent service.
None of these matters moved Justice Gzell to excuse the non-executive directors from liability for breach of their duties of care and diligence.
In accepting the task of approving the Draft ASX Announcement in the unusual circumstances in which they were asked to consider its terms, and on the basis of the information already made available to them, the non-executive directors were not simply entitled to rely upon management, their fellow directors or the company’s expert advisers. The duty to exercise care and diligence in the exercise of powers and the discharge of duties could not be outweighed by the busy nature of the role12.
Justice Gzell was satisfied that the board’s approval of the Draft ASX Announcement was a ‘negligently made misleading statement’ in a ‘deliberate attempt to influence the market to an acceptance of [the separation proposal]’13.
Responsibilities of in-house counsel
The judgment is similarly demanding of in-house counsel. Justice Gzell found that, in the absence of explanation by the executives with primary carriage of the separation proposal and the establishment of the Foundation, it was incumbent on General Counsel to advise the board of the limitations of the cash flow model14.
In relation to continuous disclosure, Justice Gzell held that General Counsel was not entitled to assume that questions of disclosure would be, or had been, the subject of advice of external legal advisers in attendance at the board meeting—at least in circumstances where the board papers did not address disclosure issues15.
Justice Gzell refused to exonerate General Counsel for breaches of the duty of care and diligence in connection with the board’s approval of the Draft ASX Announcement or with JHIL’s continuous disclosure obligations relating to the deed of covenant and indemnity.