Chiara Rawlins
Principal
Litigation and Dispute Resolution
In-N-Out of court: Trade mark wars
8 March, 2021
In March 2020 the Full Federal Court, in a considerably lengthy judgement, dismissed (2-1) an appeal by the former directors of Storm Financial Pty Ltd (Storm), which infamously collapsed in the wake of the Global Financial Crisis in the second half of 2008. On appeal, the Full Court reconfirmed that the former directors had breached their duties as directors under s 180(1) of the Act, in particular because they had caused Storm to contravene the then s 945A of the Corporations Act 2001 (the Act) which, if discovered, posed a threat to the corporation’s very existence.
Section 945A required a reasonable basis for financial product advice, characterised as “personal advice”, given to the client. That section has since been repealed and replaced with the obligation to act in the best interests of the client in relation to the provision of personal advice (section 961B of the Act).
Our previous article in relation to the first instance decision of Edelman J, ASIC v Cassimatis (No 8) [2016] FCA 1023, can be found here.
The “primary basis” for the appeal was that the trial judge misapplied s 180(1) of the Act and the “secondary basis” was that the primary judge erred in finding that Strom contravened s 945A. This article will only consider the primary contention that s 180(1) was misapplied.
Was section 180(1) misapplied, generally?
Section 180(1) of the Act sets an objective standard of care and diligence that all directors and other officers of corporations must meet when exercising a power or discharging a duty. In the words of Greenwood J at [194]:
“The objective standard is measured by the degree of care and diligence that a reasonable person would exercise if they were a director, in the corporation’s circumstances, occupying the office held by the appellants and having the same responsibilities as the appellants.”
Storm was engaged in the business of providing financial product advice, characterised as “personal advice”, to retail investors or retail clients. This had the effect of imposing on Storm the obligations required to be discharged under s 945A of the Act (now repealed). That section cast a requirement upon the financial advice providing entity to have “a reasonable basis for the advice given to the client”.
The Court noted that Mr and Mrs Cassimatis, as directors of Storm, held and maintained a high degree of control of the company, which the primary judge described as “extraordinary”, and which ranged from the highest level of executive decisions to even mundane day to day matters. This meant that as directors the scope of Mr and Mrs Cassimatis’ responsibilities under s 180(1)(b) was significantly widened, and in the circumstances, this had implications as to whether they had discharged their duties under s 180(1).
Important to the outcome of this case is the reference in the terms of s 180(1) to a reasonable person having “the same responsibilities” as the director whose conduct is impugned, as on the facts, the Court concluded that Mr and Mrs Cassimatis’ extensive involvement in all aspects of the company’s operations meant they had equally extensive responsibilities. This lead to the finding that a reasonable director in the same circumstances as Mr and Mrs Cassimatis would have been aware that inappropriate advice was likely being given to financially vulnerable clients (who were retired or approaching retirement), giving rise to contraventions by Storm of s 945A of the Act.
It was further found that a reasonable director, with the responsibilities of the directors of Storm Financial, occupying the same position, would have taken “some alleviating precautions to prevent the giving of that advice, so at guard against the devasting consequences for investors in the vulnerable class”. However, Mr and Mrs Cassimatis failed to take any such precautions.
By failing to take precautions to prevent the giving of inappropriate advice to financially vulnerable clients, the directors ignored what was viewed as a reasonably foreseeable risk of serious harm to Storm’s interests arising from likely contraventions of s 945A of the Act, including “potential loss of its AFSL and potential harm in the form of a threat to the company’s “very existence”.
Thus, the directors fell short of their objective obligations under s 180(1) through their conduct, and no error was made by the primary judge.
The majority (Greenwood and Thawley JJ) rejected the notion that the above line of reasoning was in error as it involved a “stepping stone approach” or “back-door means for visiting accessorial liability on a director”. They emphasised that Mr and Mrs Cassimatis’ contravention of s 180(1) did not arise simply because they caused Storm to contravene s 945A of the Act. Rather, properly characterised, it was the direct failure of Mr and Mrs Cassimatis to meet the standard required of them by s 180(1) that exposed the corporation to contravention of s 945A.
Whether as sole shareholders Mr and Mrs Cassimatis could validate their breaches of directors’ duties
Mr and Mrs Cassimatis also argued that the interests of the company were wrongly identified by the primary judge in an “abstract” and “theoretical” rather than in a “subjective and factual” manner. That is, Mr and Mrs Cassimatis argued that as sole shareholders and directors of Storm, they were entitled to determine what the interests of Storm were, and in particular they were entitled to prioritise the provision of advice in line with the Storm business model over “the risk of adverse action being taken by ASIC or disgruntled investors”. They argued if the Court accepted this characterisation of the interests of Storm, then no breach of s 180(1) could be found.
The majority (Greenwood and Thawley JJ)dismissed this line of argument observing that the burden cast by s 180(1) is of normative character, being a matter of public concern, not just private rights. Their Honours further held as follows:
“shareholders cannot sanction, ratify or approve, qua themselves as directors, their own conduct in contravention of s 180. Nor can they release themselves from such a contravention. That follows because of the normative, objective, irreducible standard of care and diligence directors must live up to, as adopted by the Parliament according to the text of the section …” (at [196] per Greenwood J)
…
“… it is step too far to say that 100% shareholders can approve their own contravention of s 180(1) as directors. Shareholders cannot release directors from the statutory duties imposed by ss 180, 181 and 182” (at [472] per Thawley J).
Key takeaways
- A director must always engage with their powers and duties with the degree of care and diligence that a reasonable person would exercise if they were a director of the corporation, in the corporation’s circumstances and occupying the office held by the director, and having the same responsibilities within the corporation as that director.
- It does not necessarily follow from a corporation contravening the law, even where the contravention may have extremely serious consequences for the corporation, that a director has breached his or her duty under s 180(1). The fact of the contravention will be relevant as part of the factual matrix to be considered. However, all the individual circumstances must be taken into account, including the responsibilities of and degree of control over the corporation’s affairs exercised by the director.
- The shareholders of a corporation cannot validate breaches of the above duty of care and diligence prescribed by s 180(1) of the Act. The standard is objective and mandated.
- As an artificial person, a corporation does have interests beyond simply those of its shareholders, including its reputation as well as “its continued existence and its interest in pursuing lawful activity”.
McCabes Litigation and Dispute Resolution and Corporate teams have significant knowledge and experience in the area of directors’ duties. Do not hesitate to contact us if we may be of assistance.
