When are directors liable for breaches by the company?
John Price, Commissioner
This article was submitted to the Australian Institute of Company Directors for publication in the Company Director magazine in June 2017
The issue of when directors will be liable under directors' duties for contraventions of the law by the company has been the subject of some recent judicial comment – most notably in ASIC v Cassimatis (No 8).
In the Cassimatis case, the Federal Court found Mr and Mrs Cassimatis breached their directors' duties by permitting, or failing to prevent, Storm Financial Limited (Storm) from providing inappropriate investment advice. In particular the court found that a reasonable director with the responsibilities of the Cassimatises would have been aware of a strong likelihood of contravention of the law and would have taken precautions to prevent it.
Although the Court found that Storm had in fact breached the law, Justice Edelman went further to say that he had serious doubt whether an actual breach by a corporation is a necessary requirement to prove a breach of duty by a director.
This is important to bear in mind, because it suggests that while a serious contravention by a company can serve as a good indicator that directors may have breached their duties, it is not necessarily a precondition to this finding – other factors may be relevant.
Continuing with his examination of the "stepping stone" approach of liability under directors' duties flowing from a breach of the law by the company, Justice Edelman also stated that an actual breach by a corporation is not of itself sufficient to establish a breach of duty.
So what does this mean for directors?
ASIC encourages all boards to ensure that their companies have appropriate measures in place to monitor compliance with the company's legal obligations.
However, this decision suggests compliance with the duty of care and diligence requires more than this. The relevant test to which a director will be held involves balancing the foreseeable risk of harm to the company against the potential benefits that could reasonably have been expected to accrue from the director's conduct.
Whether there has been, or foreseeably might be, a contravention of a law by the company is something directors should consider when performing this risk-benefit analysis for themselves.
In Cassimatis, Justice Edelman expanded on three elements of this risk-benefit test as it applies to contraventions of the law by the company.
Firstly, "harm" to the interests of the company is not limited to financial interests of the company, but extends to any interest of the company, which could include reputation and ability to comply with the law.
This broad interpretation aligns with a finding by the Financial Reporting Council (UK) that intangible assets now account for over 80 per cent of corporate value – so harm should be considered in that light.
The risk-benefit "balancing" involves considering what a reasonable person would have done in response to the foreseeable risk of harm. The magnitude and likelihood of risk as well as the burden of alleviating action are also relevant considerations.
A pure cost comparison, such as the cost of a penalty compared to the profit from the contravention, is not sufficient to avoid a breach of directors' duties. Nor would it be in a company's interests to engage in serious unlawful conduct even if that conduct was considered to be virtually undetected during the limitation of liability period.
The circumstances of the relevant company and responsibilities of the director are also relevant to the balancing exercise. For example, the degree of control that the Cassimatises had over the company and the relatively small burden of alleviating the relevant action were relevant factors.
The decision in Cassimatis is an important reminder to directors of their obligation to oversee the conduct of the company in light of the risk-benefit test set out above. This may include requiring the company to adopt a different course of action to alleviate foreseeable harm to the interests of the company.
Serious corporate contraventions may well lead to legal action against directors for a breach of the duty of care and diligence. However, this decision suggests such breaches may exist even if a contravention of other laws by the company has not occurred – it will all depend on the facts.
The notion that directors can be liable for corporate contraventions is not new. But the decision in Cassimatis has provided some further insight into the parameters of this liability.