Late last year the Federal Court of Australia disqualified former directors of the failed Prime Retirement and Aged Care Property Trust (the Prime Trust) from managing corporations and imposed pecuniary penalties on the directors.1
The court’s decision contains useful guidance on the circumstances in which a court will exonerate a director who has breached their duties, and on the factors that will be considered when imposing penalties on directors.
It also contains important reminders for public company directors on how they should conduct themselves in the boardroom, including:
- the need to put the interests of investors ahead of their own interests when there is a conflict of interests;
- the general requirement for a director to absent themselves from the board’s deliberations on a matter in which they have a material personal interest;
- the need for directors to deal properly with an obvious conflict of interest of another director;
- directors need to be cautious about relying on unusual or equivocal professional advice; and
- a director should take steps to consider and understand a resolution before the board and not just "wave it through" without troubling himself or herself to consider what effect it had, even if they are a new director and the board have previously considered the matter.
The rise and fall of the Prime Trust
The Prime Trust was an ASX-listed trust that owned retirement villages in Queensland, New South Wales and Victoria. Listed in 2007, it collapsed in 2010 and investors lost around $550 million.
Following the collapse, ASIC investigated the conduct of the responsible entity of the Prime Trust, Australian Property Custodian Holdings Ltd (APCHL), and the management of the trust. Subsequently, in August 2012, ASIC commenced proceedings in the Federal Court against APCHL and five former directors (Bill Lewski, Mark Butler, Kim Jaques, Michael Wooldridge and Peter Clarke).
In December 2013, the Federal Court decided that APCHL had breached its duties as responsible entity, primarily because of the payment of a $33 million listing fee from the Prime Trust to APCHL in its personal capacity, and that all of the directors had also breached their duties.2
Penalties imposed on the Prime Trust directors
In December 2014, the Federal Court made the following orders in respect of the former directors:
- Bill Lewski, the former managing director, was disqualified from managing corporations for 15 years and penalised $230,000;
- Mark Butler, a former non-executive director, was disqualified from managing corporations for four years and penalised $20,000;
- Kim Jaques, a former non-executive director, was disqualified from managing corporations for four years and penalised $20,000;
- Michael Wooldridge, the former chairman, was disqualified from managing corporations for two years and three months and penalised $20,000; and
- Peter Clarke, a former non-executive director, was penalised $20,000.
The $33 million listing fee
Since it issued its first prospectus in 2001, it had been the intention of APCHL to list the Prime Trust. By June 2006, it was likely that the Prime Trust would list on the ASX by the end of 2007.
The liability of the directors of APCHL stemmed from a decision made by the board in 2006 to amend the constitution of the Prime Trust to introduce substantial additional fees payable to APCHL in its personal capacity, being:
- a listing fee, to be payable if the Prime Trust was listed on the ASX;
- a removal fee, to be payable if APCHL was removed as responsible entity of the Prime Trust; and
- a takeover fee, to be payable if the Prime Trust was subject to a takeover.
The Prime Trust was listed on the ASX in August 2007. Just before then the board resolved to pay the listing fee. A listing fee of approximately $33 million was paid to APCHL in two tranches in 2007 and 2008. The Federal Court found that Mr Lewski received the benefit of the fee, as APCHL was controlled by persons and entities associated with him.
What caused the breaches?
The breach of duty by the responsible entity and the directors revolved around two decisions by the board.
The first was the decision to amend the constitution of the trust to allow the payment of the substantial additional fees, including the listing fee, to APCHL. APCHL obtained legal advice on its power to make the amendments. The court found the advice was “unusual and uncertain” as it provided that directors could choose between two competing interpretations: one that gave the board power to pass the amendments without unitholder approval and one that did not. The lawyers did not advise which interpretation was preferred. The directors adopted the interpretation that allowed them to make the amendments without unitholder approval.
The second was the decision to pay the $33 million listing fee to APCHL (and through it to Mr Lewski) in two tranches in 2007 and 2008.
What were the breaches?
In summary, the Federal Court found that the following breaches had been committed:
- APCHL (as responsible entity) failed to exercise a reasonable degree of care and diligence, failed to act in the best interests of unitholders, failed to prioritise unitholders’ interests over its own interests, and failed to comply with the constitution;
- APCHL (as responsible entity) contravened the related party provisions of the Corporations Act by paying the listing fee to itself in its personal capacity;
- the directors failed to exercise a reasonable degree of care and diligence, failed to act in the best interests of unitholders, failed to prioritise unitholders’ interests over the interests of APCHL (in its personal capacity) and Mr Lewski, and made improper use of their positions to advantage APCHL (in its personal capacity) and Mr Lewski; and
- the directors were involved in APCHL’s contravention of the related party provisions.
When will a director be exonerated?
Each director contended that he should be relieved from liability for his breach of duty.
The Corporations Act allows a court to relieve a director from liability for breach of duty if two requirements are met:
- the director has acted honestly; and
- having regard to all the circumstances of the case, the director ought fairly to be excused for the breach.3
The requirement for honesty is met if the director acts without deceit or conscious impropriety, without intent to gain an improper benefit and without carelessness or imprudence to such a degree that it negated the performance of the duty.
Honesty alone does not entitle a director to relief. In deciding if the director “ought fairly to be excused”, a court will consider:
- if they have acted honourably, fairly, in good faith and in a common sense manner;
- whether they obtained and followed competent expert advice;
- the seriousness of the contravention, including the degree of flagrancy and the consequences of the contravention;
- the presence or absence of contrition;
- whether the director has paid for the contravention; and
- testimonials as to the director’s service to the community, the effect of the contravention on their reputation and career, and any suffering caused to them and their family.4
The Federal Court refused to grant relief to the Prime Trust directors due to the nature and seriousness of the breaches. The seriousness of the contravention was demonstrated by the magnitude of the additional fees payable to APCHL and the importance of the fiduciary duties breached by each director. The court did not make any finding of dishonesty in respect of the directors, but did consider that they had acted with a degree of carelessness and imprudence that negated their duties.
What principles are applied when imposing a disqualification order?
ASIC may apply to the court to disqualify a person from managing corporations for a period the court considers appropriate if the person has contravened a civil penalty provision of the Corporations Act. The court may disqualify the person if it is satisfied that disqualification is justified, having regard to the person’s conduct in relation to the management, business or property of the company and any other appropriate matters.5
The Federal Court outlined a number of principles relevant to deciding whether to disqualify someone, such as:
- disqualification is designed to protect the public from harmful use of the corporate structure;
- in assessing if someone is fit to manage a company, it is necessary that they understand the proper role of a director and their duty of diligence to the company;
- the longest periods of disqualification (25 years or more) are imposed if there are large financial losses, a high likelihood of reoffending, lack of contrition or remorse, disregard for law, dishonesty;
- lesser periods of disqualification (7 - 12 years) will be imposed for serious cases if there is serious incompetence or irresponsibility, substantial loss, a lesser degree of dishonesty, wilful breach of the law, lack of contrition but a prospect of reform; and
- the shortest disqualification periods (up to 3 years) will be imposed if the director has endeavoured to repay the amounts misappropriated, has no immediate intention to manage a company, has expressed remorse and contrition.6
What principles are applied when imposing pecuniary penalties?
The court may impose a pecuniary penalty on a person who has contravened the civil penalty provisions of the Corporations Act if the contravention is serious. The maximum penalty is $200,000 in respect of each contravention.7
The primary purpose of a pecuniary penalty is to act as a personal deterrent and a deterrent to the general public against a repetition of like conduct. In calculating the amount of the penalty, the court will consider a number of factors, including:
- the penalty should be no more than is necessary to achieve the deterrent objective;
- an awareness by the director of impropriety or an intention to deprive the company of funds;
- any deliberate falsification of accounts;
- remorse and contrition by the director;
- any efforts by the director to repay misappropriated funds;
- previous unblemished character;
- the capacity of the director to pay the penalty; and
- whether the penalty will prejudice the rehabilitation of the director.8
The reasons for the Prime Trust’s directors penalties
The Federal Court noted that when other things are equal, persons involved in the same contravention should receive the same sentence, and that where other things are not equal, the differences in sentences must be rational and fair.
The court considered that Mr Lewski’s conduct was quite different from that of the other directors as he was the “driving force” behind APCHL and “instigated and then orchestrated” the breaches by APCHL in order to give himself the substantial listing fee. He had sought the legal advice that the fees could be introduced into the constitution without the need for unitholder approval, had presented that advice to the board, and had then moved with urgency to introduce the additional fees although there was no business case for urgency. He had not absented himself from the board’s deliberations on the amendments, as he was required to do.9 The court found that he put his own interests ahead of unitholders “at every step” and had shown no contrition or any understanding of his serious wrongdoing. He had also retained the $33 million listing fee.
The conduct of Dr Wooldridge, Mr Butler and Mr Jaques was found to be broadly similar. The court found that they “capitulated to the interests of Mr Lewski” and failed to deal properly with Mr Lewski’s self-evident conflict of interest regarding the listing fee. As a result the court imposed the same pecuniary penalties on those directors. Dr Wooldridge was, however, disqualified for a shorter period than Mr Butler and Mr Jaques because the court considered that he would suffer greater damage to his business career and would suffer a greater loss of income through his loss of existing directorships. The court also took into account his “exemplary character” and his “significant contribution to the community” in the area of public health.
Although Mr Clarke was found to have committed the same breaches as the other directors, the court considered that he was less culpable than them as he had not been a director of APCHL at the time of the board meeting to approve the constitutional amendments to introduce the new fees, and had only been a director for one day before the second board meeting to approve the lodgement of the amendments with ASIC. As a result there was no requirement to impose a disqualification order on him. He had, however, been “a passive participant” at the second board meeting and had “just waved it [the resolution] through without troubling himself to consider what effect it had”, and so the court considered that a pecuniary penalty was appropriate.
Appeals lodged by directors and ASIC
Each of the Prime Trust directors has appealed the Federal Court’s decision.
ASIC has also appealed the length of the disqualification and the amount of the pecuniary penalty imposed on Mr Lewski and the amount of the pecuniary penalties imposed on Dr Wooldridge, Mr Butler and Mr Jaques.
It is expected that the appeals will be heard in May 2015.