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COVID-19: A Timely Reminder of Directors’ Duties

Posted by Krishneel Nath on 22 Jun 2020

Australian Securities and Investments Commission (ASIC) recently published an article titled “Director duties in the context of COVID-19” and in conclusion noted that ASIC will continue to investigate and take enforcement action as warranted by the public interest against directors or companies that break the law. It serves as an important reminder that although these are tough economic times, directors should not lose sight of their duties.

Introduction

The caution issued by ASIC is particularly relevant, as companies in recent months have had to grapple with dramatic changes to their business environment. Companies are (or thinking of) recalibrating their corporate strategy and funding models. These difficult times may also expose potential (existing) breaches of director duties and possibly, contraventions of the law by their companies.

On 27 March 2020 and just as COVID-19 restrictions were being implemented, the Federal Court of Australia Full Court (Court) delivered a judgment in the matter of Cassimatis v Australian Securities and Investments Commission [2020] FCAFC 52. The decision is timely as it relates to the directors of the infamous Storm Financial Pty Ltd (Storm) and breach of their statutory obligations which were exposed during the Global Financial Crisis (being the last significant global economic event). This article revisits some of the matters identified by the Federal Court which inform the content directors’ duty under section 180(1) of the Corporations Act 2001 (“Act”) and in particular explore the Court’s approach in considering that duty in the context of there being a risk that the respective company may breach the Corporations Act 2001

Duty to exercise care and diligence

Section 180(1) of the Act imposes a duty on directors to exercise their powers and discharge their duty with a degree of care and diligence that a reasonable person would exercise if they (a) were a director or officer of a company in the corporation’s circumstances; and (b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

The Court made the following general observations as to the content of the statutory duty to exercise due care and diligence:

  1. the “corporation’s circumstances” include all relevant commercial and other circumstances, including any breach or risk of potential breach of the law by the corporation;
  1. all the responsibilities of the director are to be considered regardless of how and why they have those responsibilities. These responsibilities are not limited to statutory obligations imposed on the director under the Act but also include whatever responsibility the director has within the corporation; and,
  1. duty of care and diligence is normative and its burden is a matter of public concern not just private rights.

Ratification by the shareholders does not absolve an impugned director for a breach of his or her duty under the Act

It is a common misconception that the shareholders of a company can ratify the actions of the director where those actions are in breach of the director’s statutory duties, and that such ratification absolves the director of further or other liability. This misconception particularly resonates in cases where the directors and shareholders are one and the same (common in small companies), where ratification may be implied.

The Court in the case of Cassimatis makes plain that “…shareholders cannot sanction, ratify or approve, qua themselves as directors, their own conduct in contravention of s180. Nor can they release themselves from such a contravention. That follows because of normative, objective, irreducible standard of care and diligence directors must live up to…”. Simply put, shareholders cannot absolve a director who breaches a duty under the Act by ratifying his or her conduct.

Does the contravention of law by the company mean that the director has also breached their duties as directors?

The contravention of the law by the company does not, in of itself, mean that the director has breached his or her duty. In the case of Cassimatis, the Court recognised that “companies are often formed and operated to permit the taking of risks that individuals may not be willing to assume themselves and that it is of the essence of commercial activity to take risks”.

The focus of the enquiry when assessing the conduct of the director and whether the director has met the standard imposed on him or her is to be assessed by reference to the words of section 180(1) of the Act. The foreseeability of a risk that the company may contravene the law is to be considered when assessing the factual matrix relevant to the company’s circumstances under section 180 (1) of the Act “but the liability of the director under s180(1) is direct and not derivative from the company’s contravention.”

In the case of Cassimatis, it was noted that Storm relevantly gave financial advice to investors who had “five matters in common: (i) they were over 50 years old; (ii) they were retired or approaching and planning for retirement; (iii) they had little or limited income; (iv) they had few assets, generally comprised of their home, limited superannuation, and limited savings; and (v) they had little or no prospect of rebuilding their financial position in the event of suffering significant loss.”

In doing so, Storm breached s945A (1)(b) and (c) of the Act, by providing advice to investors:

  1. “without investigating and considering the subject matter of the advice sufficiently, having regard to the information obtained from the investors.”
  1. “which was not appropriate having regard to the consideration and investigation of the subject matters of the advice.”

However, in Cassimatis, the directors were found to have failed to discharge their duty of exercising care and diligence as with their extensive responsibilities within Storm and acute awareness of the business model of Storm, a reasonable director in the circumstances would have:

  1. known that there was a strong likelihood that Storm would contravene the Act if the directors continued to permit Storm to give advice under the current model;
  2. known that such contraventions would likely be discovered by ASIC;
  3. considered that there was a real possibility that ASIC would take regulatory action including possible suspension or cancellation of Storm’s AFSL; and,
  4. accepted that it was in Storm’s interest to not give inappropriate advice to the relevant investors.

Conclusion

The responsibilities and duties of directors are derived from a number of sources, which include the Act (including various other provisions within the Act), equity and the common law. It is not intended to explore all of the duties and responsibilities of directors in this article.

However, COVID-19 may have put some of the conduct or duties of directors under the spotlight and therefore it is important for directors to be aware of their duties as they continue to navigate a way forward.

If you require assistance in understanding your obligations or have concerns and require advice, please feel free to contact a member of Coleman Greig’s Litigation & Disputes team, who would be more than happy to assist you today.