Directors have a legal duty of care to avoid any risks that may foreseeably harm their organisation. Identifying those risks is a crucial issue, says Professor Pamela Hanrahan.
In late March, 13 months after the case was heard and more than a decade after the relevant conduct occurred, the full Federal Court handed down its decision in Cassimatis v Australian Securities and Investments Commission [2020] FCAFC 52.
By a majority of two to one, the Full Court upheld the 2016 decision of Justice James Edelman that Emmanuel and Julie Cassimatis breached their duty of care as directors of Storm Financial. Storm was a licensed financial advice firm based in Townsville that had rolled out a highly leveraged investment strategy to its clients in the years leading up to the global financial crisis (GFC). Storm contravened the financial services laws by recommending the strategy to clients for whom it was unsuitable. For many Storm clients, the strategy resulted in catastrophic losses when markets fell in December 2008.
The case is unusual because ASICâs only claim was that the defendants had breached the duty of care in s 180(1) of the Corporations Act 2001. ASIC did not allege that Mr and Mrs Cassimatis personally had breached the financial services laws, that they were liable as accessories to Stormâs breach of those laws, or that they had failed to act in good faith in the interests of Storm. Before the GFC, Storm was solvent and the defendants were its only shareholders. The case therefore turned on whether the damage Storm â as a corporate entity â suffered because of its breach of the financial services laws was foreseeable and therefore that the directors had a duty to take reasonable care to avoid it.
Stepping stones
Justice Edelmanâs 2016 decision was handed down just before he went to the High Court of Australia and attracted significant attention from directors and lawyers. It confirmed that under Australian law, statutory directorsâ duties have a public character and can be contravened, even if the shareholders do not want to complain. It also tested ASICâs enforcement approach â sometimes referred to as âstepping stonesâ â of bringing proceedings against directors whose negligence put their company at risk of suffering the consequences of breaching other laws.
All three appellate judges were satisfied that Storm had breached the financial services laws, and Justices Andrew Greenwood and Thomas Thawley (in separate judgements) agreed with Justice Edelman that Mr and Mrs Cassimatis had been negligent. But Justice Steven Rares did not, and his strongly worded dissent points to some of the inherent limitations of the stepping-stones case theory.
As Justice Greenwood observed, the statutory duty of care, âis normative and its burden is a matter of public concern, not just private rights. It is an expression of the parliamentâs intention to establish an objective normative standard of the degree of care and diligence directors must attain or discharge in exercising a power conferred on them or in discharging a duty to be discharged by themâ.
Justice Thawley noted that, âthe interests of the company to which the duty is owed include the interests of the corporate entity itself, the shareholders and, at least where the financial position of the company is precarious, the creditors of the companyâ. Directors must exercise reasonable care to avoid foreseeable risk of harm to those interests.
Established authority makes clear that s 180 does not create in directors a duty to ensure their company always complies with the law. Nor can it be used to make directors liable as accessories to their companyâs breach of applicable laws if those laws do not create that liability or the directorâs state of mind does not meet the threshold requirements for establishing it. The use of the shorthand âstepping stonesâ should not obscure the fact that the elements of negligence must be made out â that is, ASIC must show that the director has failed to take appropriate action to prevent the company itself suffering a foreseeable harm. Deciding what is appropriate involves balancing the likelihood and magnitude of the harm against the cost and practicability of the measures needed to prevent it.
Duty of care
None of this is news. The real controversy is over how the duty of care applied to the behaviour of Mr and Mrs Cassimatis before the GFC emerged on the horizon. At first instance, Justice Edelman had concluded they fell short of the required standard of care âby exercising their powers in a way which caused or âpermittedâ (by omission to prevent) inappropriate advice to be givenâ, when the âconsequences of that inappropriate advice would be catastrophic for Storm (the entity to whom the directors owed their duties). It would have been simple to take precautionary measures to attempt to avoid the application of the Storm model to this class of personsâ.
Justice Greenwood said that Stormâs breaches of the financial services laws were important, ânot because the contraventions by Storm of those sections of the Act would give rise to a contravention by the directors of s 180(1) in the form of some sort of dystopian accessorial liability, but rather because the contraventions by Storm, deriving from the conduct of the appellants themselves, as described, contained within it a foreseeable risk of serious harm to Stormâs interestsâ. That harm would be, âa potential loss of its AFSL; a threat to Stormâs very existence; and suit by the vulnerable investors to address the consequences of the advice given to them and thus the contraventions by Stormâ. Which, Justice Greenwood said, âreasonable directors, with the responsibilities of Mr and Mrs Cassimatis, standing in Stormâs circumstances, ought to have guarded againstâ.
Justice Rares disagreed, concluding that the harm (ASIC action against Storm) was not foreseeable in 2007â08 and therefore did not trigger the duty to avoid it in the way the majority decided. âWhile Mr and Mrs Cassimatis were responsible by their (unintended) negligence for Stormâs contraventions of [the financial services law], I am not satisfied that a reasonable director in their position in all of the circumstances came under a duty under s 180(1) to prevent the contraventions for the reason that the primary judge found: namely, that âthe consequences of that inappropriate advice would be catastrophic for Stormâ. I am not satisfied that he or she should have perceived a risk, or likelihood, of ASIC taking action to suspend or cancel Stormâs AFSL or the imposition of a banning order and then that he or she should have acted, for that reason, to prevent that action occurring.â
The legal principle is clear: directors have a duty to take reasonable care to avoid any foreseeable risk of harm to their company â including through reputational damage or regulatory action â that would result from it breaking the law. But the case will turn on what was foreseeable when the conduct occurred, and not afterwards, particularly when black swan events have intervened.
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