Two recent cases have confirmed important corporate governance rules relating to shareholder consent to directors’ conduct and shareholders’ rights to remove directors.

First, the Storm case demonstrates that the unanimous consent and involvement by a company’s shareholders in the misconduct of its directors does not absolve the directors from a breach of their statutory duty to exercise reasonable care and diligence. The statutory duty requires a director to make an objective assessment of the rewards and risks that may follow for the company from a proposed course of action.

Second, the State Street case clarifies that the statutory procedure for removing public company directors in section 203D of the Corporations Act 2001 (Cth) (Act) is not an exclusive procedure for removing directors. The case illustrates the importance of a company’s constitution and other governing documents (such as shareholders’ agreements) in setting corporate governance rules.

Further information about each case follows.

Storm: Shareholder consent does not absolve breach of section 180(1)

The separate article by Greg Golding and Taylor MacDonald in this edition of On Board summarises ASIC’s successful pursuits against directors in civil penalty proceedings, including those of Storm Financial Limited (Storm).

Storm provided various financial advice to its clients including, recommending to invest money in an index fund and obtaining a margin loan, effectively “double gearing”. ASIC alleged that the model was flawed and inappropriate, and breached section 945A(1)(b) and (c) of the Corporations Act. Therefore, ASIC alleged, personal liability should be imposed on Storm’s directors under section 180(1).

A unique aspect of the Storm case was that the company’s only shareholders were its directors. The directors relied on this to argue that their conduct was not in breach of section 180(1) of the Act.

The court cited earlier statements from the High Court of Australia that it is not possible for shareholders to ratify a director’s breach of the statutory duty of reasonable care and diligence under section 180(1) of the Act. The court also reiterated the basic principle that while the interests of the company and its shareholders are often aligned, they are not always entirely coincident.

Applying these principles, the court held that although the directors were Storm’s only shareholders, they did not have carte blanche to engage in a venture which was highly likely to, and did, result in serious contraventions of the Act. The directors’ serious misconduct exposed the company to significant financial harm and such misconduct could not be absolved by the common identity between the directors and shareholders.

The court in Storm further observed that the argument that the directors’ statutory duty of reasonable care is not enlivened or has no content if the company’s shareholder consent to the directors’ conduct has no support in the text of section 180(1). Rather, the principal defence to a breach of the statutory duty of care is the business judgment rule under section 180(2) of the Act. Significantly, the directors abandoned relying on the business judgment rule in the Storm case. It would therefore have been an odd result for them to be exculpated based on their dual identity as the company’s sole shareholders.

State Street: Removing public company directors without using section 203D

In State Street, the removal of an independent director was sought by a securityholder under the company’s constitution. State Street Australia Ltd, custodian of the only remaining external investor, brought proceedings arguing that the constitutional power to remove directors was abrogated by section 203D, which instead provided the exhaustive mechanism for removing directors.

Section 203D of the Act gives a public company’s shareholders a right to remove its directors “despite anything” in the company’s constituent documents.

The recent decision of Beach J in State Street clarifies that section 203D is not the exclusive pathway for removing directors of public companies. Company directors may be removed by other pathways, including using procedures set out in the company’s constituent documents.

For a decade prior to State Street, there has been uncertainty as to whether section 203D is the exclusive method for removing a public company’s directors. The issue has practical importance because the section 203D procedure is cumbersome. It requires the calling of a formal meeting of the shareholders, with notice to be given to the company at least 2 months before the meeting.

The uncertainty surrounding section 203D arose in 2007, when Bryson AJ in the Scottish & Colonial decision found that compliance with the procedures set out in 203D was mandatory for removing a director from the board of a public company. Bryson AJ reasoned that the strength of the language used in section 203D demonstrates the legislative intention that the provision operate whether or not there are constitutional provisions which give directors less or no protection.

Since the decision of Bryson AJ, several judges and academic commentators have cast doubt on the apparent exclusivity of section 203D.

The decision of Beach J in State Street adds weight to the contrarian views and leaves Bryson AJ’s decision as an outlier.

In finding that section 203D is not an exclusive method for removing public company directors, Beach J observed that the phrase “despite anything in… the company’s constitution” simply operates to override a constitution to the extent of inconsistency with section 203D. Section 203D does not purport to be the exhaustive or exclusive mechanism available to remove a public company director. It prescribes that a company “may” remove a director by the procedure described therein; it does not provide that it “may only” do so.