NSW Court of Appeal delivers decision on appeal of penalties in James Hardie case; High Court grants special leave

Background

On Friday, 6 May 2011 the New South Wales Court of Appeal (Spigelman CJ, Beazley and Giles JJA) handed down a joint judgement in appeals against refusal to grant relief from liability, disqualification and pecuniary penalty orders by a former company secretary and general counsel and the former CFO of James Hardie Industries Limited (JHIL) (Morley v ASIC (No 2); Shafron v ASIC (No 2) [2011] NSWCA 110).

It follows from the directors and officers judgment of the NSW Court of Appeal on 17 December 2010, in which liability for breaches was considered.

The proceedings arose out of the establishment by JHIL of the Medical Research and Compensation Foundation (Foundation) in 2001 to compensate asbestos victims.  Under a Deed of Covenant and Indemnity (DOCI), JHIL agreed to make annual payments to its subsidiaries.  An ASX announcement of 15 February 2001 stated that these arrangements were sufficient to fund all present and future asbestos claims, which turned out not to be the case.

Overview of NSW Court of Appeal decisions

Following an appeal, Mr Shafron, the then company secretary and general counsel, was found to have breached a duty of care and diligence as he failed to advise that the DOCI should be disclosed to ASX and he failed to advise the board on the limitations of a “best estimate” of exposure to asbestos claims.  Mr Morley, the former CFO, was found to have breached a duty of care and diligence as he had failed to advise the board of the limited nature of reviews of a cash flow analysis by certain experts.

In this most recent decision, the Court of Appeal dismissed an application by Mr Morley for relief against liability.  Although the Court found that Mr Morley was acting honestly while failing to disclose important expert information to the board, the Court refused to exercise its discretion to grant relief.  The Court stated:

Proper corporate governance and business activity depend on business leaders adhering to standards not only of honesty but also of care and diligence, and a failure of the nature and seriousness of that of Mr Morley is not in our view one which can properly be excused.

Mr Shafron did not maintain an appeal against Gzell J’s decision (at first instance) to refuse to grant relief from liability.

Pecuniary penalties awarded against Mr Shafron and Mr Morley were reduced on appeal to $50,000 and $20,000 respectively.  Mr Morley will be disqualified from managing corporations for two years from 27 August 2009 (reduced on appeal from five years).  Mr Shafron was unsuccessful in his appeal to have the period of disqualification reduced and he will be disqualified for seven years from 27 August 2009.

Implications – The responsibility of non-director executives

In the context of making findings in relation to relief from liability, disqualification and pecuniary penalty, the Court of Appeal confirmed the seriousness of knowingly or negligently withholding relevant information from the board and the market. Non-director executives should therefore carefully consider advice to the board to ensure that all relevant matters are accurately explained and that a misleading impression is not conveyed (including by omission).

Where a breach of the duty of care and diligence is of a sufficiently serious nature, directors and officers will not be relieved from liability even if they acted honestly – the law will hold them to their duty of reasonable care and diligence and may impose severe pecuniary penalties and disqualification orders.

Implications – Appropriate delegation

This appeal decision did not revisit the other significant aspects of the previous judgments in these proceedings.

For example, at first instance, Gzell J considered that where management seeks board approval of public statements concerning a major transaction or corporate action, directors are not entitled to abdicate responsibility for approving and releasing those statements by delegating responsibility to other directors, management or advisers who may have greater expertise in the substance of the matter – each director must decide whether the statement should be approved based on their knowledge of the matter.  Accordingly, delegations by the board to approve changes to public statements should be expressly subject to a requirement that substantive or significant changes be returned to the full board for its consideration.

Similarly, in its judgment of 17 December 2010, the Court of Appeal held:

The non-executive directors, with their familiarity with the importance of sufficiency of funding and whether an assurance of sufficiency could be given, could not properly accept the say-so of management. … [I]t was a matter for application of the directors’ minds, and not just assurance from management or advisers.  The standard practice, if followed, would not relieve the directors from applying their own minds to whether such an important announcement was misleading.

While the Court of Appeal stated that not every ASX announcement must go before the board, it refused to specify what matters would be important enough to require all directors to be involved.

This may also have important implications for delegations by the board more generally. Accordingly, delegations in the context of major transactions or corporate actions should be carefully considered to ensure that directors are able to satisfy themselves that they have fulfilled their responsibilities.

The High Court grants special leave to appeal