Upcoming Mallesons seminarsSenior executives and officers of companies who face potential liability for their acts and omissions in the course of performing their duties.
What do you need to do?Ensure the internal reporting systems in your company are effective in identifying issues relevant to the company.
Tim Bednall
Partner, Chairman of the Board
T +61 2 9296 2922
Sydney
Tim Bednall
Brian Murphy
Melbourne
Alison Lansley
Diana Nicholson
Perth
Nigel Hunt
Brisbane
John Humphrey
Canberra
David Briggs
When a corporation breaks the law, suffers loss or causes loss or damage to its stakeholders, the executive officers often face legal proceedings against them personally. The potential liability of these officers arises under a range of state and federal legislation, including the Corporations Act 2001.
This edition focuses on the potential liability for executive directors and other senior executives in a number of areas. We discuss:
- the National Greenhouse and Energy Reporting Act 2007 - recent Federal legislation which proposes civil penalties for chief executive officers where the corporation breaches that legislation
- key lessons from the NSW Court of Appeal’s decision ASIC v Vines - a case which concerns the duty of care and diligence owed by a chief financial officer during a takeover
- due diligence issues associated with rights issues, in light of the Corporations Legislation Amendment (Simpler Regulatory System) Act 2007, and
- developing trends in the enforcement of the continuous disclosure provisions of the ASX Listing Rules and Corporations Act against executives.
The feature common to each of these items is the role effective risk management and internal reporting systems can play in reducing the potential liability of executive officers and the companies they manage.
The National Greenhouse and Energy Reporting Act 2007 (Cth) establishes a national framework for reporting greenhouse gas emissions, abatement actions and energy consumption and production by corporations. For more information please see our National Greenhouse and Energy Reporting Bill alert.
In a corporate governance context, the Act is of interest as it implements some of the recommendations arising out of the Corporations and Markets Advisory Committee’s (CAMAC) Personal liability for corporate fault report, released in September 2006. We discussed this report in our Corporate Governance Update in March 2007.
A key feature of the enforcement framework under the Act is to impose, in certain circumstances, civil penalties on Chief Executive Officers (CEO) of corporations that contravene the new legislation. These civil penalty provisions are based on the extended accessorial liability model for corporate officers proposed in the CAMAC report. That liability model, developed in the context of criminal liability, contemplates that personal liability should be based on actual acts or omissions rather than a person’s office or role.
Under the Act, a CEO will be liable for all breaches for which the corporation has civil liability if:
- the CEO either had knowledge of, or was reckless or negligent as to whether the contravention would take place
- the CEO was in a position to influence the conduct in question, and
- the CEO failed to take all “reasonable steps” to prevent the contravention.
The inclusion of a “reasonable steps” due diligence defence follows another recommendation in the CAMAC report. The Act sets out what the court is to have regard to in determining whether a CEO failed to take all reasonable steps. This includes:
- whether the CEO arranged regular professional assessments of the corporation’s compliance
- whether any appropriate recommendations arising from such assessments were implemented, and
- whether the CEO took action to ensure the corporation’s employees, agents and contractors had a reasonable knowledge and understanding of the requirements to comply with the legislation.
Under the Act the CEO may be ordered to pay a penalty equal to that which the court could impose on the corporation for contravening the provision in question.
The Act is an early indication that the recommendations contained in the CAMAC report will be followed in the drafting of new federal legislation. The Act demonstrates that those recommendations may be followed not only in a criminal context, but also in respect of civil liability provisions applying to corporate officers. The adoption of the recommendations is a welcome development as it enhances certainty and provides limits on the circumstances which can lead to personal liability for corporate officers.
Author
Cherie Canning, Solicitor
We have previously reviewed the judgment of Austin J in the case of ASIC v Vines. The case involved assertions that Mr Vines, the former chief financial officer (CFO) of the GIO group and other GIO executives, had breached their statutory duty of care.
Earlier this year the NSW Court of Appeal upheld key aspects of the first instance judgment and ordered that Mr Vines pay a pecuniary penalty of $50,000 in respect of his contraventions of the old Corporations Law.
The case is of interest because it explores in detail the role of a CFO of a target company, during a takeover with close consideration of the due diligence process established in connection with the publication of the Target’s statement. The judgment also touches on the importance of robust internal reporting systems.
Factual background
Mr Vines was the CFO during the period that GIO was the subject of a hostile takeover in 1998. He had broad responsibility for the financial reporting and tax affairs of the GIO group. Following the takeover bid, he assumed a central position in the takeover response process and, importantly, was given special responsibility by the Board for ensuring the integrity of financial information in the Target’s statement (including the profit forecast). He served on the due diligence committee (DDC) established by the Board to prepare the Target’s statement, along with 5 non-executive directors and representatives from GIO’s solicitors and financial advisers.
During the bid period, Hurricane Georges caused a major natural disaster in the Caribbean. The damage caused by Hurricane Georges resulted in significantly higher than expected liability exposure to GIO under certain reinsurance contracts.
The central issue in the case was whether Mr Vines had adequately discharged his duties in keeping the DDC and, through it, the Board informed of the impact of Hurricane Georges on the profit forecast disclosed in the Target’s statement.
Relevant findings on appeal
A majority of the New South Wales Court of Appeal upheld three of Austin J’s findings that Mr Vines had contravened the statutory duty of care and diligence in the Corporations Law.
The key failings of Mr Vines in connection with takeover process were as follows.
- Mr Vines gave his management sign-off to the DDC, without qualification regarding the potential impact of Hurricane Georges on the profit forecast for the company’s reinsurance business. The court held that it did not matter:
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- Mr Vines failed to:
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Lessons from the Vines decision
There are a number of lessons that can be drawn from the Court of Appeal’s decision. Whilst the judgment concerned a CFO’s role in a takeover, the findings also have application where a company is issuing a prospectus, product disclosure statement, or even an announcement required by the continuous disclosure regime.
- In giving the unqualified management sign-off, the executive takes personal responsibility for the matters stated in it. The sign-off is a representation that the signatory has taken appropriate steps, through inquiry, to ensure the accuracy of the matters certified.
- In reporting to the board, a CFO’s role is to be the “arms and legs” of the non-executive directors, and the CFO must keep them fully informed of key financial information and profit forecasts. The directors are likely to rely on the weight of the CFO’s authority and are entitled to expect a properly formed judgment. A company’s non-executive directors cannot discharge their responsibilities unless senior executives of the company, having responsibility to do so, lay before them all material information.
- Where a company has published profit forecasts, there is an ongoing duty on the responsible executives to monitor whether new circumstances will impact on whether the forecasts will be materially affected. In part, Mr Vines was held responsible for the failures of subordinates charged with monitoring the situation to report to him.
- Where the board delegates particular responsibility for preparation of a document to an individual, that individual may be held liable, even where a number of others are involved as members of a committee which approves the document.
We have previously reported on the purpose of the new regime for undocumented rights issues in our alert Undocumented Rights Issues and Non-traditional Rights Issues- ASIC Relief Update- 2 October 2007.
The discussion below focuses on some of the implications of the new regime for executive directors.
Liability exposure for undocumented rights issues
Where a prospectus or product disclosure statement is prepared in connection with a rights issue, executive directors face potential liability under the Corporations Act for misleading and deceptive statements in the prospectus or product disclosure statement.
These provisions will not apply to undocumented rights issues, removing a potential source of director’s liability. Equally, the due diligence defence of having made reasonable inquiries in connection with the preparation of a prospectus (or product disclosure statement), will not apply to a rights issue conducted without a prospectus or product disclosure statement under the new regime.
However, executive directors will still face potential liability under section 1308 the Corporations Act, in connection with publication of the cleansing notice and any other related documents required to implement the undocumented rights issue. Section 1308 imposes liability on persons who authorise statements which are false or misleading in a material particular, or any omissions which make the publications false or misleading in a material respect, without having taken reasonable steps to ensure that the statements (or omissions) were not false or misleading.
Officers and employees will also face potential liability for making available or giving information to the directors, without having taken reasonable steps to ensure the information is not false or misleading (section 1309 of the Corporations Act).
In addition, the issuer faces potential liability in connection with the rights issue under a range of generally applicable sections of the Corporations Act, including section 1041H, which relates to misleading and deceptive conduct. Directors, officers, employees and advisers face potential liability for being involved in a contravention of section 1041H (or other provisions of the Corporations Act) by the issuer.
The role of internal reporting systems
As no prospectus or product disclosure statement is required, it is expected that issuers will be able to prepare the documentation required to conduct the rights issue more quickly. However, because issuers and directors are still potentially liable for statements in the documents which are published, implementation of an appropriate due diligence process is still important.
Market practice in the conduct of undocumented rights issues is still developing. It is likely that entities wishing to conduct undocumented rights issues expeditiously will conduct a due diligence process similar to those used when a rights issue prospectus or product disclosure statement is prepared. Issuers may be more reliant on the effectiveness of the company’s ongoing risk management and internal reporting systems so that the process can be conducted efficiently and expeditiously.
In those circumstances, independent directors are likely to be more dependent on the senior executive management team bringing to their attention any issues which need to be disclosed.
Accordingly, executive directors will need to ensure that all potential disclosure issues are reported to assist them to take reasonable steps prior to conducting an undocumented rights issue to minimise the risk of liability for their company and themselves.
Listed entities and their directors face potential liability in connection with compliance with the continuous disclosure obligations under the ASX Listing Rules and Corporations Act. Liability can arise in a number of ways, including as a result of breaches of section 674 of the Corporations Act (the requirement to comply with the continuous disclosure provisions of the ASX Listing Rules) or a breach of section 1041H.
While the primary liability under these provisions is imposed on the listed entity, executives can be held liable as accessories if they are involved in a contravention by the entity, or even be held individually liable for engaging in misleading or deceptive conduct in connection with a breach by the listed entity. An executive officer may also be prosecuted for breaching their duty of care in connection with the defective disclosure.
Recent proceedings in which ASIC has sought orders against executive officers in connection with allegedly defective disclosures by a listed entity include those brought against:
- the managing director of Citrofresh International Ltd
- the CEO of Fortescue Metals Group, and
- the former CEO and CFO of James Hardie.
In the case of Citrofresh, the company has admitted to breaching section 1041H. The proceedings against Citrofresh’s managing director for engaging in misleading and deceptive conduct and breach of his duties of care and diligence, were heard in September 2007 and judgment has been reserved.
The court’s approach to the assessment of penalties for executive officers will be followed closely.
Assessing penalties for breach - the importance of internal reporting systems
ASIC, in the matter of Chemeq Limited v Chemeq Limited [2006] FCA 936, involved proceedings by ASIC against the company for breaching its continuous disclosure obligations. French J discussed a number of the principles relevant to assessing the penalty to be imposed on the listed entity. These principles are also likely to be relevant when related claims are made against individual executives.
Two of the factors cited by French J in assessing the penalty were:
- the existence of compliance systems in relation to its disclosure obligations, including provisions for and evidence of education and internal enforcement of such systems, and
- remedial and disciplinary steps taken after the contravention and directed to putting in place a compliance system or improving systems and disciplining officers responsible for the contravention.
These points reinforce the importance of maintaining effective internal control and reporting systems for listed entities and the senior executives who design and implement those systems.
The positive steps taken by senior executives to encourage compliance with the continuous disclosure regime and procure that material matters are disclosed in an appropriate and timely fashion, will be directly relevant to the assessment of penalties for breaches. Conversely, those issuers and executives who are unable to demonstrate their commitment to compliance with the continuous disclosure regime may face greater penalties.