The decision focuses on the approval of consolidated financial statements in 2007 by the directors of Centro Properties Limited (CPL), Centro Property Trust (CPT) and Centro Retail Trust (CRT), collectively referred to as “Centro”. The reports fell short of the requisite accounting standards by misclassifying or omitting to disclose significant financial liabilities.  

The subtleties of the decision have potentially broad implications on the relationship between the Board and management, specifically relating to the flow and control of information placed before the Board for consideration when making decisions. The onus now rests on the Board to properly manage the information on which it bases its decisions, in the effective discharge of its standard of care.

Background - The 2007 Centro financial reports

At a joint meeting of the Boards of the Centro entities, the directors unanimously:

  • Resolved to approve the consolidated financial statements of CPL, CPT and CRT and their controlled entities for the year ending 30 June 2007  
  • Resolved that declarations be made in writing by the directors that:
    • the financial statements complied with Accounting Standards, the Corporations Regulations 2001 and other mandatory professional reporting requirements  
    • the financial statements gave a true and fair view of the financial position of CPL, CPT and CRT as at 30 June 2007  
  • Resolved that in the opinion of the directors:
    • with respect to the CPL, CPT and CRT 2007 accounts, the financial statements and notes were in accordance with the Corporations Act 2001 (the Act) and the company’s Constitution  
    • there were reasonable grounds to believe that CPL, CPT and CRT would be able to pay their debts as and when they became due and payable  
  • With respect to the CPL, CPT and CRT 2007 accounts, resolved that the Directors’ Reports and Directors’ Statements be approved, and that the statements and declarations be signed by any two directors and be annexed to the financial statements.  

Misclassified liabilities

The CPL 2007 Accounts provided:  

  • The total of interest bearing liabilities for CPL and its controlled entities which were classified as current as at 30 June 2007 was $1,096,936,000.  
  • The total of interest bearing liabilities for CPL and its controlled entities which were classified as non-current as at 30 June 2007 was $2,506,815,000.  

The CPT 2007 Accounts provided:  

  • The total of interest bearing liabilities for CPT and its controlled entities which were classified as current as at 30 June 2007 was $1,096,936,000.  
  • The total of interest bearing liabilities for CPT and its controlled entities which were classified as non-current as at 30 June 2007 was $2,506,750,000.  

The CRT 2007 Accounts provided:  

  • The total of interest bearing liabilities for CRT and its controlled entities which were classified as current as at 30 June 2007 was $nil.
  • The total of interest bearing liabilities for CRT and its controlled entities which were classified as non-current as at 30 June 2007 was $1,433,979,000.  

On the evidence before him, Justice Middleton found that as at 30 June 2007, CPT, CPL and their controlled entities in fact had current interest bearing liabilities totalling $2,611,033,581 which were wrongly classified as non-current on the CPL and CPT balance sheets.  

Further, his Honour found that as at 30 June 2007, CRT in fact had current liabilities totalling $598,292,097 which were wrongly classified as non-current on the CRT balance sheet.

Claims by Australian Securities and Investments Commission

ASIC alleged that the actions of the Centro directors constituted a breach of their duties under the Act, specifically sections 180 and 344. ASIC also alleged that by issuing certificates declaring that the 2007 Accounts were compliant, the directors were in breach of section 295A of the Act.

The legislative requirements

Section 344 of the Act provides:  

“A director of a company, registered scheme or disclosing entity contravenes this section if they fail to take all reasonable steps to comply with, or to secure compliance with, Part 2M.2 or 2M.3”.

Parts 2M.2 and 2M.3 of the Act both enumerate in detail what is required of companies in the maintenance and reporting of financial records.

In evaluating the requirements of section 344, Justice Middleton noted:

“The director’s obligation, under section 344 is to take all reasonable steps to comply, or secure compliance, with Pt 2M.3 (which deals with financial reports, directors’ reports, audit, reporting to members and lodgement with ASIC). They are under the same duty with respect to the financial records which the entity must keep under Pt 2M.2. If they fail to take all reasonable steps to comply or secure compliance, they contravene the Act”.

His Honour continued, stating:  

“Whilst the obligation to “prepare” it is placed on the entity, the directors have an important responsibility for the contents of the report. Additionally, the financial report which a company must prepare must contain a declaration by the directors that the financial statements comply with the accounting standards and give a true and fair view, and must contain the directors’ opinion as to whether there are reasonable grounds to believe that the entity will be unable to pay its debts as and when they become due and payable and as to whether the financial statements are in accordance with the law: section 295(4)”.

The Act therefore places a positive duty on directors to ensure a company’s reports comply with the relevant accounting standards, and requires that directors positively declare their belief to that effect in the form of a certificate under section 295(4).  

Section 180 of the Act imposes on directors a more general duty of care in the discharge of their duties and obligations with the degree of care and diligence that a reasonable person would exercise if they were a director or officer in the corporation’s circumstances and occupied the office held by, and had the same responsibilities as, the director or officer. Justice Middleton noted:

“In determining whether a director has exercised reasonable care and diligence … the circumstances of the particular corporation concerned are relevant to the content of the duty. These circumstances include: the type of company, the provisions of its constitution, the size and nature of the company’s business, the composition of the board, the director’s position and responsibilities within the company, the particular function the director is performing, the experience or skills of the particular director, the terms upon which he or she has undertaken to act as a director, the competence of a company’s management, the competence of the company’s advisors, the distribution of responsibilities within the company and the circumstances of the specific case”.

Relationship between section 180 and section 344

ASIC alleged that the same conduct gave rise to a breach of both sections of the Act. In considering the interplay between the provisions, his Honour held:

“In my view, the interplay between section 180 and section 344 in the circumstances of this case is simply this:

  1. The directors were required by section 180 to be diligent and careful in their consideration of the resolution to approve the accounts and reports.  
  2. The directors were required by section 344 to take all reasonable steps to secure compliance with the relevant provisions of the Act, and to at least inquire about any potential deficiency in the accounts and reports that they observed or ought by the exercise of the requisite care and diligence to have observed”.  

Therefore while section 180 imparts a general duty of diligence and care in the directorship of a corporation, section 344 requires of directors more specific duties in relation to ensuring compliant financial reporting. It appears that a failure by a director to observe the specific requirements of section 344 necessarily results in a breach of the general requirements of section 180.

Directors’ submissions

The Centro directors’ core submission was that relevant accounting rules had recently changed, and they could not have known that the misclassified short-term liabilities in question were current under those rules. The directors also claimed that in light of the complexity and volume of the information handed to them, they were reasonably entitled to place reliance on Centro management’s procedures for ensuring accounting/reporting compliance in discharge of their duties under the Act.

Two broad issues arose from the Court’s dismissal of that submission. First, the general standard of care imposed on directors pursuant to section 180 will vary according to the circumstances of the corporation at hand. Secondly, once the applicable standard of care is ascertained, the Board cannot rely on management to discharge the specific responsibilities associated with that standard, or blame ‘information overload’ from management for failing to exercise due care and diligence.

The “floating” standard of care under section 180

Justice Middleton held the directors failed to exercise the degree of diligence and care required of them under section 180 in light of Centro’s particular circumstances, and placed undue reliance on company management in the discharge of their duties relating to financial reporting. Setting the tone, his Honour held that the importance of true and fair financial reporting is “one of the fundamental reasons” why directors are required to approve them.

In evaluating what constitutes ‘taking all reasonable steps’ adequate to discharge directors’ duties under the Act, his Honour focussed on the circumstances of the relevant corporation: “What is encompassed by taking ‘all reasonable steps’ will differ depending on the entity, the complexity of the entity’s business and the internal reporting procedures within the entity”.

His Honour was clear that the test was fundamentally objective; that is, the standard of care a reasonable person in the position of the director would exercise in light of the circumstances of the relevant entity.

Turning to Centro’s circumstances, Justice Middleton reviewed in detail the group’s well-organised and extensive management and governance structure, including the Risk Management sub-committee of the Board. In light of these circumstances, his Honour held that each of the directors was aware, or should have been aware, of the misclassified short-term liabilities.

As such, his Honour held that “each director armed with the information available to him was expected to focus on matters brought before him and to seriously consider such matters and take appropriate action”.

Unreasonable reliance on management

The Court rejected the directors’ argument that their reliance on information from management was an adequate discharge of the duty to properly consider the financial reports placed before them.

His Honour noted that the Act places on the Board and each director individually the specific task of approving financial statements: “Directors cannot substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the Board’s responsibilities, as with the reporting obligations”.

As to the directors’ claim that their failure was due in part to the volume and complexity of the information provided by management, his Honour placed the onus on the Board in limiting and managing the information placed before it: “A board can control the information it receives. If there was an information overload, it could have been prevented … The complexity and volume of information cannot be an excuse for failing to properly read and understand the financial statements. It might be so for less significant documents, but not for financial statements”.  

Regarding the issue of the certificate, his Honour rejected the contention that ensuring compliance was the exclusive domain of financial accountants and general counsel. The approach his Honour preferred “may come close to placing a burden on each director akin to each director having not only to take reasonable steps to secure compliance with the Act, but actually complying with the Act”. His Honour did not regard this obligation as “onerous”.

Implications for directors

The decision demonstrates the importance of Board-control over its processes and procedure in discharging its relevant standard of care. Directors should ensure that the information provided by management is independently considered and measured for compliance. The Board should not simply lean on management, but must take a proactive approach in filtering and examining what is placed before it, to the standard appropriate in the circumstances.  

His Honour’s position hints at the possibility that the Board, in discharging its standard of care, should distinguish between ‘significant’ financial information and ‘lesser’ information placed before it by management. Information overload is not a valid excuse. By corollary, this raises the question: What distinguishes ‘significant’ from ‘lesser’ documents/information?

In keeping with his Honour’s approach, it is possible that the answer will depend on the standard of care expected of a particular Board, taking into account its corporation’s circumstances. The higher the requisite standard, the more diligent the Board should be in what information is placed before it for consideration. In other circumstances, less pressing issues may warrant the Board’s use of ‘information control’, such that it is not distracted from more pertinent questions. In the case of Centro, the pressing nature of impending current liabilities probably meant related information/documents constituted ‘significant’ information to which the Board should have properly turned its collective mind, unfettered by volumes of relatively insignificant information.