This article is written by Will Heath and Lauren Taylor.
In the aftermath of the Hayne Royal Commission, ASIC has confirmed that its Office of Enforcement will focus on individual accountability of company directors and executives for breaches of the Corporations Act.[1]
ASIC has a particularly strong track record of successfully suing company directors and executives which we have reported elsewhere. That track record has been improved following the High Court's recent decision in ASIC v Lewski [2018] HCA 63 (Lewski).
This note summarises the High Court's decision in Lewski and its implications for company directors and executives.
ASIC's fight to the end
The Lewski litigation followed the collapse of Australian Property Custodian Holdings Ltd (APCHL), which was the responsible entity (RE) of the Prime Retirement and Aged Care Property Trust (a managed investment scheme) (Prime Trust). At the time of its collapse and appointment of administrators in 2010, APCHL owed approximately $550 million.
In 2012, ASIC sued the five former APCHL directors (including a former non-executive director). ASIC's claim focused on the conduct of the Board in 2006 when it amended the constitution of Prime Trust to facilitate payment of a listing fee to APCHL. APCHL was owned by interests associated with one of the directors, Mr William Lewski. The constitutional amendments resulted in a fee of approximately $33 million being paid to APCHL after Prime Trust was successfully listed on ASX in 2007.
ASIC's claim focused on the Board's conduct in determining to amend the Prime Trust constitution without member approval and without clear legal advice, and despite the fact that APCHL was owned by interests associated with one of its directors, Mr Lewski. The directors argued that they honestly believed they were entitled to approve the Prime Trust constitutional amendments without member approval and they made the decisions accordingly.
ASIC claimed, among other things, that the directors had breached three key statutory duties owed by them as directors of an RE: first, to exercise reasonable care and diligence (under section 601FD(1)(b) of the Corporations Act); second, to act in the best interests of Prime Trust's members and give priority to those members' interests over their own interests (section 601FD(1)(c)); and, third, not to make improper use of their position (section 601FD(1)(e)).
ASIC won a Federal Court trial against the directors and in 2014 the Court awarded various civil penalties and disqualification orders. However, the directors appealed and in 2016 the Full Court of the Federal Court overturned the trial decision. ASIC in turn appealed the Full Court's decision and in December 2018 the High Court reinstated the trial judge's decision that the directors had breached their duties.[2]
High Court's guidance on directors' duties
The appeals to the Full Court of the Federal Court and the High Court largely involved technical arguments in relation to the time at which breaches of directors' duties occurred and whether or not ASIC's action was time-barred by applicable limitation periods. This note does not examine those points.
Rather, the relevance of the High Court's decision for company directors and executives is principally in its observations regarding the scope of statutory directors' duties (set out above) owed by each director in their capacity as an officer of the RE of the Prime Trust. Although these statutory duties apply only to officers of the RE of a registered scheme (and not to non-RE companies),[3] their scope and content largely mirrors the general statutory duties of all directors and officers set out under sections 180 to 183 of the Corporations Act.
Statutory duty of care and reliance on legal advice
The High Court confirmed that a director's compliance with the statutory duty of care and diligence under section 601FD(1)(b) will be measured objectively having regard to the degree of care that a reasonable person would exercise tailored to the circumstances of the director.
Critically, the board of APCHL failed to take reasonable care because they did not properly consider the nature or propriety of the substantial and "effectively gratuitous" listing fees and the legal advice which the board had received regarding the power to make the constitutional amendments was "equivocal". The trial judge had found, among other things, that the legal advice received by the board regarding the proposed constitutional amendments essentially left it to the board (none of whom were legally qualified) to determine which of two potential interpretations was correct.
In affirming the trial judge's decision, the High Court observed that a reasonable person in the position of each director faced with the question of whether the constitutional amendments required member approval would either have obtained clear legal advice, or a direction from a court (regarding the efficacy of the amendments), or would otherwise have sought member approval. The Board was therefore negligent by proceeding to effect the constitutional amendments on the basis of equivocal legal advice.
Statutory duties of loyalty: Honesty is not enough
Officers of an RE owe two duties of loyalty under section 601FD(1)(c) of the Corporations Act: first, to act in the best interests of members and, second, if there is a conflict between members' interests and the interests of the RE, to give priority to members' interests. Although the section 601FD(1)(c) duty does not apply to directors of non-RE companies, it is based on similar principles to section 181 of the Corporations Act which requires every company director to act in good faith in the best interests of the company.
The High Court affirmed that the statutory duty to act in the best interests of members does not require a director to secure the best outcome for members. The court's focus is on propriety of purpose, not the success of outcome.
Additionally, it was observed that neither of the loyalty duties are purely subjective. It is insufficient that a director honestly believes he or she is acting in members' best interests. The High Court upheld the trial judgment's finding that no director could reasonably have believed it was in the best interests of members to approve the constitutional amendments. The board should have voted against the resolutions.
Impropriety will be assessed objectively
The High Court's final observations were in relation to the statutory duty of an RE officer not to make improper use of their position to gain, directly or indirectly, an advantage for themselves or anyone else, or to cause detriment to the members of the scheme.[4] This duty is substantially the same as section 182 of the Corporations Act, which requires company directors and officers not to improperly use their position.
The High Court reaffirmed that, for the purposes of the statutory duty, impropriety is not limited to consciously bad behaviour. Impropriety is assessed objectively by reference to a breach of the standards of conduct that would be expected of a person in the position of the director by reasonable persons with knowledge of the duties, powers and authority of the position and the circumstances of the case. Impropriety may consist of doing something that a director or officer knows or ought to know that they have no authority to do.
The High Court approved the trial judgment's reasoning that the purpose of the constitutional amendments was to provide an advantage to APCHL and, indirectly, Mr Lewski.
Where next?
The High Court's decision isn't the end of the Lewski litigation. The proceedings have been remitted to the Full Court of the Federal Court for determination of what effect the decision has on the penalties and disqualification orders made against the directors, together with certain cross-appeals by ASIC about the adequacy of the penalties.
In the meantime, final victory in the High Court has emboldened ASIC. ASIC Commissioner John Price recently stated that the High Court's decision "shows that ASIC's willingness to take hard cases and litigate them through to superior Courts when needed. ASIC has the people, the powers and the desire to hold those engaged in misconduct to account".[5]
[1] https://download.asic.gov.au/media/5011933/asic-update-on-implementation-of-royal-commission-recommendations.pdf. This follows Recommendation 6.2 of the Royal Commission Final Report which stated "ASIC should adopt an approach to enforcement that takes, as its starting point, the question of whether a court should determine the consequences of a contravention."
[2] ASIC did not appeal the Full Court's decision which exonerated one of the five directors, Mr Clarke.
[3] Corporations Act section 601FD.
[4] Corporations Act section 610FD(1)(e).
[5] https://asic.gov.au/about-asic/news-centre/find-a-media-release/2018-releases/18-377mr-high-court-decision-on-prime-trust-directors/
