Directors' Counsel

Professor Bob Baxt outlines a recent case that illustrates the difficulty in persuading courts to exonerate breaches of duty.

Forgiving directors for breaches of duty

In the recent decision of Australian Securities and Investments Commission (ASIC) v Cassimatis (No. 8) [2016] FCA 1023 (Cassimatis), Justice Edelman, in an important judgment, dealt with a number of interesting issues of corporate law arising out of the prosecution by ASIC against the directors of Storm Financial Limited (Storm). That company had been the centre of one of the most highly publicised financial collapses in recent Australian corporate history. Millions of dollars were lost by a range of investors who were provided with specific advice in relation to their potential investment in the schemes prepared by Storm.

ASIC sued the sole shareholders who were also the directors of the company, namely Mr and Mrs Cassimatis. ASIC alleged that they had breached a number of duties, and in particular, their duties to act with care and diligence in the management of the company. In the course of his lengthy judgement of well over 100 pages, Justice Edelman had to deal with what he described as a unique argument in Australian corporate history. He noted (at para 2): “First, the allegations of breach against the directors rely upon a single provision of the Corporations Act 2001 (Cth) (the Act) s180(1) [the duty of care and diligence]. Secondly, the directors’ breaches of care and diligence are alleged to have occurred while Storm was a solvent company and while [the directors] were the only shareholders. Thirdly, there is no dispute that [the directors] managed Storm in good faith and in accordance with the informed wishes of all the shareholders (themselves).”

The rather unique argument put forward by the directors of the company was that they could not be held to be in breach of the duty of care and diligence because they were the sole directors and shareholders of the company. Justice Edelman was not prepared to accept this argument (the reasons for rejecting it are not discussed in this note but may be the topic of an interesting further contribution).

Breaches of duty

The major issue I want to discuss in this short review was the ability and willingness of the court to forgive directors for any breaches of duty that may have occurred during their role as directors of the relevant company, pursuant to sections 1318 and 1317 of the Act.

In my experience, these sections have rarely been applied in favour of company directors to forgive them for breaches of duty in a variety of scenarios. Two recent cases in which the sections have been applied successfully in favour of directors are Hall v Poolman (2007) 65 ACSR 123 and McLellan, re The Stake Man Pty Ltd v Carroll (2009) 76 ACSR 67. The power to forgive was also a key feature of the decision of Justice Middleton in ASIC v Healey [No. 2] (2011) 196 FCR430 – in which Justice Middleton refused to exercise his discretion in favour of directors.

It does surprise me that judges are not more generous in providing relief to directors in appropriate cases, especially where they tried to rescue companies which, often through no fault of their own, have found themselves in financial difficulty. In this case, however, the factors were quite different. There is little doubt that there would be an appeal in this case from the decision of Justice Edelman to find in favour of ASIC against the directors.

The power to forgive

At paragraphs 789 to 824 of the judgment, Justice Edelman considers in some detail, the history of the relevant provision (which was based on provisions in trustee legislation) in which similar relief may be granted by the court where breaches of trust occur. In his discussion, he reviews some of the earlier decisions in which the corporate law section has been applied. It is unnecessary to review those earlier decisions.

One of the most interesting differences between the current statutory provision and the original provision is the omission of the word “reasonably” from the language of the relevant section. The court is now no longer asked to consider whether it was reasonable for the directors to be forgiven. Justice Edelman noted, however, that although “reasonableness” was “no longer a requirement before a person can be excused”, nevertheless, “the reasonableness of conduct remains a relevant consideration in the context of the discretion concerning whether the relevant party ought ‘fairly’ to be excused from liability” (at para 809). In the view of the judge, the expression “ought fairly to be excused”, which is still part of the section, is “capable of incorporating reasonableness as a consideration. This is particularly so since the assessment must take place (i) ‘in all of the circumstances of the case’, and (ii) in light of the express incorporation of what might be seen as reasonableness [set out in]section 1317S(3)”(at para 810).

Assessing behaviour

The judge then considered the behaviour of the relevant directors. He agreed that they acted honestly. He also agreed that they genuinely believed that the steps that they were taking to protect those who had invested in the company were sensible steps in relation to the investment and related matters. He accepted that they had been warned in strong terms both by ASIC and by others, that they should have taken more steps to alleviate the potential financial collapse of the company. But, in all the circumstances, he believed that their very powerful position as the sole directors of the company required them to seek additional expert assistance in order to run the company more successfully. He was impressed by the fact that they had provided assistance to certain retirees and others who had lost significant funds as a result of the collapse of the company (which in turn has of course led to very highly publicised class action litigation against the company and the directors).

Taking into account all of this, Justice Edelman concluded that these matters, “provide a significant argument for relief from liability,” (at para 824). But, as noted earlier, the discretion that was vested in the judge is a very important one. And he decided that he was “not ultimately satisfied that Mr and Mrs Cassimatis should be excused from liability.

Their roles and responsibilities in Storm were so significant, and the contraventions were sufficiently serious, that their conduct ought not fairly be excused. They were responsible for establishing the Storm model, which provided double gearing for thousands of clients. They exercised an extraordinary level of control and power over the Storm business and should reasonably have known the consequences of inappropriate advice to any class of client could reasonably be expected to be catastrophic for Storm (to whom their duties were owed). The approach they took was to create an advanced model, an assistant for application of the model, to be applied at almost every circumstance where it was possible to borrow enough money for the application of the model to a client who satisfied Storm’s conditions, including using the client’s family home as part of their asset portfolio for the purposes of applying the model,” (at para 824).

In the circumstances, and in his view, this combination of events made it clear that clients of Storm were vulnerable. The application for relief was therefore rejected. In all the circumstances, Justice Edelman felt that ASIC had established that the directors were in breach of their duty to act with care and diligence and that they had also breached other provisions of the legislation.

One final comment on the approach taken by Justice Edelman to the duties of directors in cases of this kind is worthy of note. His judgment contains a wide-ranging discussion of many earlier cases in which the question of the duties of directors had been carefully considered by a range of courts. He highlighted in particular the decision of the High Court of Australia in Shafron v The Australian Securities and Investments Commission [2012] HCA 18. That decision is indeed a very specific landmark decision and a very high level of care and diligence is now expected of directors. If one needed any confirmation of that particular assessment, one needs only to review some of the recent cases involving the administration of managed investment schemes and in particular the decision of Justice Wigney in Trilogy Funds Management Limited v Sullivan & Others (No. 2) [2015] FCA 1452.

This case was discussed in the August issue of Company Director (p54) and is worthy of review.