In brief

The Federal Court has found that the directors of Storm Financial – one of the high profile collapses of the GFC - breached their directors’ duties.

Justice Edelman concluded that the directors breached their duty of care and diligence, under section 180 of the Corporations Act, by permitting (or failing to prevent) the Storm Financial model being applied indiscriminately to clients who were retired or near retired with limited income and few assets. This model involved investors borrowing against their homes and obtaining margin loans to invest in index funds. The Court found that a reasonable director would have realised that there was a strong likelihood that retired or near-retired investors would be inappropriately advised to use their homes as security for their investment.

In reaching that conclusion, the Court explored various important concepts arising in respect of the directors’ duty of care and diligence. In particular, the decision confirms that in exercising care and diligence, directors must think beyond the financial consequences of a particular action or approach and consider all of the possible harm that may arise – including reputational harm and potentially, the loss of a licence arising from a failure by the company to comply with the law.

Is company misconduct a necessary stepping stone to a directors breach?

ASIC’s case relied upon an actual breach by the company as a “stepping stone” for a finding that the directors breached their duty under section 180 of the Corporations Act. Although actual breach was in fact made out, Edelman J queried whether ASIC had set itself an unnecessarily high bar, expressing some doubt as to whether a contravention by the company was a necessary requirement for a breach by a director. If it were a requirement, this would lead to the unusual result that a director might escape liability for an act which was extremely likely to involve a serious breach of the law, simply because by some good fortune no actual breach occurred.

Can section 180 be used as to create “back door” accessory liability?

Relatedly, Edelman J rejected the notion that section 180 can be used to create liability in directors merely because their companies have contravened another provision of the Corporations Act – “back door” accessory liability. He rejected a submission made by ASIC that there was some general duty imposed on directors to ensure that the corporation meets its statutory obligations - there is no strict liability duty to ensure compliance. Edelman J confirmed the conclusion from ASIC v Mariner Corporation that it is wrong to assert that if a director causes a company to contravene a provision of the Corporations Act, then necessarily the director has contravened section 180.

Edelman J did, however, confirm that contraventions or the risk of contraventions by the corporation are circumstances to be taken into account in assessing whether a director or officer exercised care and diligence – they are not the only circumstances, and they are not conditions of liability.

The Court also considered the concept that any breach of section 180 must be “founded on jeopardy to the interests of the corporation” (an expression arising from the decision of the Court in ASIC v Maxwell and discussed in later decisions). Edelman J described this expression as “short-hand” for the idea that if the interests of the corporation are not threatened (or foreseeably harmed), there cannot be any breach. In the context of a breach of the law, the relevant jeopardy is the threat of damage to the interests of the corporation which include exposure to sanctions. The risk of exposure to liability or sanctions must be clear to the directors and the countervailing potential benefits insignificant.

Is financial harm the only concern in thinking about the directors’ duty of care and diligence?

Under section 180, whether a director has exercised care and diligence can only be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably be expected to accrue. The mere fact that there is a foreseeable risk of harm to the interests of the company will not necessarily mean a director has failed to exercise care and diligence.

In exploring the content of the duty under section 180, Edelman J noted that harm is not confined to financial harm. It extents to harm to any of the interests of the corporation, including its reputation and interests which relate to compliance with the law (e.g. the potential loss of a licence).

[482] …it would be hard to imagine examples where it could be in a corporation’s interests for the corporation to engage in serious unlawful conduct even if that serious unlawful conduct was highly profitable and was reasonably considered by the director to be virtually undetectable during a limitation period for liability.

Edelman J also concluded that the balancing exercise to be undertaken in determining whether the duty has been breached is not a literal weighing of costs against profits. A director will not necessarily avoid liability merely by showing that the likely financial cost of a penalty for breaching the law was exceeded by the likely profit from the contravention.

Are directors who are the sole shareholders of a solvent company effectively excused from section 180?

The directors in this case asserted that there could be no breach of section 180 where a director of a solvent company has the consent of the shareholders in embarking on a course which is highly likely to contravene provisions of the Corporations Act. They argued that where the directors and shareholders are the same, as was the case here, such a ratification by the shareholders is implicit.

Edelman J rejected the directors’ submission on this point, finding that the right to exercise business judgment does not give a director/ shareholder carte blanche to engage in any venture, even if the venture is highly likely to (and does) contravene the law. He found that while the acquiescence of shareholders (including where there is an identity of interests between directors and shareholders) can affect the duty of care and diligence, it does not relieve the directors of their duties where there are other relevant interests of the corporation, apart from the interests of shareholders. These interests do not always coincide.

Is a breach of the statutory directors’ duty of care and diligence a public wrong?

Edelman J explored a question raised by the parties as to whether a breach of the obligation in section 180 of the Corporations Act toexercise care and diligence is both a private and a public wrong.

The directors argued that the duty is essentially a private duty owed only to the company, with a public component reflected in ASIC’s ability to pursue enforcement and impose public sanctions. They also argued that in a solvent company, the only interest of the company is the interest of its shareholders.

In contrast, ASIC argued that section 180 creates an independent public duty requiring consideration of a “general norm of conduct” which is not limited to the interests of the corporation – it is a duty which requires consideration of the public interest.

While Edelman J did not consider it necessary, in the relevant context, to resolve this question, he did explore the possibility that the relevant text in the Corporations Act and contextual considerations might indicate that a public duty is owed.

In the current climate, where ASIC is repeatedly emphasising that “culture is the new black”, this possibility of a broader public duty raises questions about the extent to which directors might be at risk, regardless of harm to shareholders, for failures of the company and its employees.