The duty of care and diligence revisited - recent leading opinion and guidance by the AICD and the Courts

In an era of heightened scrutiny and evolving regulatory landscapes over corporate accountability, the duties and responsibilities of company directors have never been more critical. Recent guidance has provided valuable insights into Section 180(1) of the Corporations Act 2001 (Cth), with the release of an opinion by Michael Hodge KC and Sonia Tame on section 180(1) commissioned by the AICD, the AICD's subsequent Practice Statement with regard to Director’s oversight, and recently concluded litigation such as the case of ASIC v Ryan.[1]

In this article, we outline the key findings and recommendations from this recent guidance, offer our commentary, and discuss the implications for directors.

The Hodge and Tame Opinion and AICD Practice Statement

On 8 October 2024, the AICD released the Hodge and Tame opinion, commissioned to clarify the standard of care required under section 180(1) of the Corporations Act. The opinion addressed the AICD’s key questions regarding directors' duties in regulatory compliance, including the applicability of standard safe harbours available to respond to alleged breaches of section 180(1). The AICD also issued a Practice Statement premised on the advice provided in this opinion, advising company directors on how the duty should be applied.

To read the specific findings made in the Hodge and Tame Opinion, see here.

To read the subsequent recommendations made in the AICD Practice Statement, see here.

KWM’s Observations and Commentary

We largely agree with the findings of both the Hodge and Tame Opinion and the subsequent AICD Practice Statement. Both the opinions and the statement provide evidence-based guidance for directors on fulfilling their duty of care and diligence under s 180, addressing both financial and non-financial risks. These resources are particularly helpful for directors in understanding how to comply and what defences may be available if a breach occurs. However, there are a few areas in both the Opinion and Practice Statement that are not settled. Our observations on those areas are set out below.

1. Directors must understand the company’s key compliance obligations and be in a position to monitor risks

We agree with the Hodge and Tame Opinion that directors should have some understanding of their company’s key compliance obligations and be able to monitor management with their company’s key compliance obligations. In our view, this does not mean that directors are required to have a full understanding of their regulatory compliance obligations, nor explicitly monitor actual compliance unless a red flag arises.

The Hodge and Tame Opinion references the case of Re HIH Insurance Ltd (in prov liq),[2] which states that directors should take reasonable steps to guide and monitor management, including having general oversight of corporate affairs and policies. In our view, this means that directors must ensure systems are in place to for management to manage compliance risks and be able to monitor, report, escalate and respond to these risks as they arise. Directors should also ensure that they meet the requirements of the reliance and delegation “safe harbours” from liability under s180(1). This can be achieved by regularly attending board meetings, ensuring they have a general understanding of the types of risks that may arise, and receiving reports from those managing these systems. Directors cannot rely on silence: they can’t assume that silence from management means that systems are in place and working effectively.

2. Directors are at risk of breaching section 180(1) where they do not take appropriate action when there is a foreseeable risk of serious harm to the company

We agree that directors are at risk if they do not take appropriate action to address a foreseeable risk with a viable response. However, in some cases, no suitable action may be available to address such a risk. The test for whether a foreseeable risk has an appropriate action is based on the 'Shirt calculus' from Wyong Shire Council v Shirt,[3] which considers the probability of the risk, the gravity of the harm, the cost and difficulty of taking action, and any conflicting responsibilities. While we advise directors that it is generally unwise to assume no appropriate actions can be taken, a proper assessment of these factors must occur to determine the suitability of any action, regardless of the risk's foreseeability.

3. Whether a director has breached their obligations includes consideration on what they knew or should have known or realised had they made proper enquiries

While we agree with Hodge and Tame that this may be a factor the court must consider in determining whether a director has breached their duty, we do not believe that directors have an obligation to make enquiries of management about compliance risks when there is no red flag indicating a foreseeable risk. A director should certainly make reasonable enquiries when put on notice or if they have a suspicion or concern. Directors would also be well-advised to make regular enquiries about the management of risks that are “mission critical” to the company’s operations or financial position. However, it is impractical for a director to constantly monitor every area of the company’s compliance obligations without any suspicion or reason to suspect a risk.

4.The level of oversight over compliance risks should be commensurate with the materiality of those risks and the likelihood of those risks materialising. Not all risks should be treated equally.

We agree that the impact and likelihood of risk occurrence will vary depending on the specific risk and the business circumstances at the time. Most companies have developed risk matrices classifying risks in this manner, and the board should focus on the management of those risks with a higher potential impact (including impact on reputation) and/or a higher likelihood of occurrence. That said, the board should ensure that the management compliance function has identified and is monitoring compliance with all material regulatory obligations.

Affirming the guidance – ASIC v Ryan case

As noted in the Hodge and Tame Opinion, directors are generally entitled to rely on expert advice provided by others, unless they know, or should know, of facts that indicate they cannot or should not rely on that advice. This reliance defence, established under section 189 of the Corporations Act, was a key focus in the case of ASIC v Ryan.[4]

In August 2023, ASIC initiated civil penalty proceedings against Dixon Advisory director Paul Ryan in the Federal Court. ASIC alleged that Ryan breached his duties as a director by making decisions that allegedly favoured Dixon Advisory’s holding company, E&P Operations, despite Ryan being a director of E&P Operations and failing to properly consider the interests of Dixon Advisory’s creditors. These decisions included:

• Amending the constitution of Dixon Advisory on 22 December 2021 to authorise directors to act in the interest of E&P Operations; and
• Executing a deed of acknowledgement on 24 December 2021 between Dixon Advisory and E&P Operations allegedly to the advantage of E&P Operations and the detriment of Dixon Advisory.

This deed imposed conditions adversely affecting Dixon Advisory’s right to recover a $19 million debt owed by E&P Operations and failed to consider the interests of creditors as Dixon Advisory was approaching insolvency.

Ryan submitted that he had not breached his duties as a director, as he had relied on legal advice from MinterEllison regarding the deed of acknowledgement.

On 6 November 2024, the Federal Court found in Ryan’s favour, dismissing ASIC’s case and ordering them to pay Ryan’s fees on the basis that:

1. Ryan relied on the advice in respect of resolving to approve both the amendment to Dixon Advisory constitution and Dixon Advisory’s entry into the deed of acknowledgement;
2. MinterEllison was a professional advisor in relation to matters that Mr Ryan believed on reasonable grounds to be within its professional competence, namely the provision of legal advice in the specific context of corporate transactions, solvency issues and compliance with director’s duties; and
3. he relied on MinterEllison’s advice in good faith and after making an independent assessment of the advice, which involved him reading the advice carefully and satisfying himself that the background assumptions on which it was based were accurate and complete.

The court reached the conclusion that had the advice told Ryan that he would have been breaching his director’s duties by resolving to execute the deed of acknowledgment, that he would not have resolved to do so.

The Federal Court's decision in favour of Paul Ryan underscores the significance of section 189 and the ability of directors to rely on expert advice, provided that they do so with reasonable grounds and in good faith, after making an independent assessment of the advice and verifying its accuracy and completeness. This case also highlights the importance of obtaining and carefully considering professional advice in complex corporate matters, particularly when potential conflicts of interest and shareholder or creditor considerations are at stake.