Executive or non-executive directors

Introduction

Directors, whether executive or non-executive, should always carry out their duty in a high standard of care. All directors and officers of a company are bound by a number of general law and statutory duties. According from Daniels v Anderson (1995), the case clarifies that the same standards are imposed on both executive and non-executive directors.

In this essay, a short summary about ASIC v Adler will be provided, followed by an explanation of each of the Corporation Act Adler had contravened by relates it to the principle law and lastly a conclusion of this assignment.

In ASIC v Adler (2002), HIH, HIHC, Adler Corporation Pty Ltd (Adler Corporation), Mr Adler, Mr Williams and Mr Fodera had contravened the Corporations Act. These findings are explained below.

ASIC v Adler (2002) Case

This case basically deals with four types of transactions. The main defendants were Rodney Adler (a substantial shareholder and non-executive director of HIH, also an officer of HIHC), Ray Williams (the founder and Chief Executive Officer of HIH) and Dominic Fodera (a director and Chief Financial Officer of HIH).

In June 2000, Casualty and General Insurance Co Ltd (HIHC), a subsidiary of HIH Company, provided an unsecured and undocumented $10 million loan to Pacific Eagle Equity (PEE), a company controlled by Adler. The transfer was performed by Dominic Fodera. The 10 million loans were arranged without any knowledge of other directors of HIH.

PEE became the trustee of Australian Equities Unit Trust (AEUT), which controlled by Adler Corporation (Adler was only the director and he and his wife, the only shareholders). Units were then issued by AEUT to HIHC at a value of $10 million. However, the value of the trust that PEE managed was worth less than $10 million. PEE used the $10 million loan in the following transaction:

  • Approximately $4 million loan was used to acquire HIH shares on the stock market. Adler intended to create a false impression to the stock market that he was helping HIHs falling share, hopping to increase the share price, or at least prevent the share price from falling dramatically. Shortly, PEE sold HIH shares at a $2 million loss.
  • Nearly $4 million loan was used to purchase of unlisted shares in unlisted technology and internet companies from Adler Corporation. Unfortunately, Adler Corporation suffered the total loss on these investments.
  • About $2 million was lent to Adler and the associated interest without sufficient documentation and it was an unsecured loan.

Courts decision

The court held that:

  1. HIHC illegally provided financial assistance of $10 million to PEE to obtain shares in HIH. No disclosure was made to other directors or to the investment committees. Furthermore, the $10 million unit trust subscribed by HIHC was worth less than the initial subscription. As a result, this action materially prejudiced the interest of HIHC, HIH and the shareholders. Thus, section 260A was contravened.
  2. Adler had convicted multiple breaches of directors duties. There are under section 180, 181, 182 and 183 of the Corporations Law.
  3. Williams had contravened his director duties under section 180 and 182 of the Corporations Law. He failed to ensure the presence of a proper safeguard before allowing HIHC to lent $10 million to PEE.
  4. Fodera had contravened his director duties under section 180(1) of the Corporations Law. He failed to submit a proposal to HIHs boards or the investment committees approval for lending $10 million to PEE.

Directors Duties

Under the Corporate Law, a director can be defined as a person who acts in the position of director, regardless of name called or whether he/she validly appointed as an official director. Breach of the duties may not only be detrimental to the companies but also may result in civil and criminal liability. As mentioned above, Adler had contravened Sections 180 to 183.

The Corporations Law requires directors to:

  • (s180) Act with care and diligence
  • (s181) Act in Good faith (bona fide)
  • (s182) Avoid improper use of position, and
  • (s183) Avoid improper use of information

Duty to act with due care and diligence

Section 180(1) of the Corporation Act states that directors or other officers in a company is essential to discharge their powers and duties with proper care and diligence as if a reasonable person would have acted if they:

  1. were a director of the company, and
  2. occupied the office held by, and had the same obligations within the company as the director

In ASIC v Adler, a reasonably careful and diligent director would not have allowed HIHC to loan the sum of $10 million to PEE to use some of the amount to procure HIHs share. Adler also failed to ensure that safeguards were in place to protect HIHC. In fact, Adlers intention was to support HIHs share price for his own substantial shareholding. Furthermore, nearly $4 million was used to acquire unlisted shares. These companies where facing cash flow difficulties and there was a significant risk that these companies would collapsed.

Justice Santow held that:

  • to determine whether a director has act on reasonable care and diligence, a question must be asked; what a normal person with same knowledge of Adler, would respond to this situation if he/she was acting as a director
  • court will consider the companys condition and directors obligation and position within the company
  • a director was appointed because of his/her expertise in certain area of the company
  • business judgment rule can be applied to director, provided that the director has acted in good care and diligence

It is essential for all directors, whether executive or non-executive, to act in a minimal standard of care and diligence, stated under Daniels v Anderson (1995).

Business Judgement Rule

Section 180(2) of the Corporation Act implemented a protection to a director to make a business judgement will only apply if the duty of care and diligence is carried out where all the following aspects are shown:

  • the judgement was executed in good faith for a proper purpose
  • did not have material personal interest with the company
  • informed themselves about the subject matter of the judgement which they rationally believed to be appropriate
  • rationally believed that the judgement was carried out in the best interest of the company

These beliefs can be viewed as a rational business judgement unless none of the directors would have acted similarly. Section 180(2) provides directors from personally liable for their decision made in good faith and in the best interest of the company. One of the main reasons to enforce business judgment rule is to encourage directors to be more risk taking because they are assured by this regulation that if they perform their duty in honest, they will not be liable if something goes wrong.

Adler brought up the defence of the business judgment rule to avoid the liability for contravened section 180(1). The court concluded that the defence, section 180(2), was not valid to protect Adler. The rule may be invoked only if a decision is made and will not cause the company to suffer loss because the directors failed to act good faith for a proper purpose.

Duty to act in good faith in best interest of the company

Section 181(1)(a) of the Corporation Act states that a director should perform their power and duties in good faith in the interests of the company as a whole. The requirement to perform in good faith is generally refer to an obligation to act honestly.

Two tests, a subjective and an objective, are required for the court to determine whether a director has breached the duty to act bona fid (good faith).

  • the court studies the actual intention of the director to conclude whether he or she was honest, and
  • the court judges whether a reasonable person, in the directors position, would have perform alike under the same circumstances

Adler used some of the money to purchase HIH share for his own interest in order to make a gain for his own shareholding in HIH. He has also contravened related party transaction provisions contained in section 208 and 209, and the financial assistance provisions contained in section 260A-260D of the Corporations Act. The payment caused interest conflict between Adler personal interest and the companies in pursuing profits. Santow J held that Adler had contravened his duty to act in good faith in the interest of HIH and HIHC.

Duty to act for a proper purpose

Section 181(1)(b), a director must perform their power and duties for a proper purpose. There is a close link between proper purpose and duty of good faith. Thus, duties to act in good faith in the best interest of the company and for a proper purpose are often considered together. For example, if a power is carried out without a proper purpose, it will probably be contrary to the companys interest.

An improper purpose can be defined under the cases of Howard Smith Ltd v Ampol Petroleum Ltd (1974), where it was primarily engaged in to dilute the majority shareholdings. A director can be in breach of section 181 where his or her power is performed for an improper purpose, even if he or she believes he or she is acting honestly.

Adler acted for an improper purpose by seeking to obtain a benefit from the unsecured loan by using part of the funds to purchase HIH shares. Adlers intention was trying to benefit himself at the detriment of HIH.

Avoid improper use of position

Section 182(1) of the Corporation Act prohibits a director to inappropriately utilize his or her position to:

  • achieve an advantage for himself/herself or someone else, or
  • cause detriment to the company

In the case of R v Byrnes and Hopwood (1995), section 182 does not require proof that the director actually achieved his or her purpose to gain an advantage for himself/herself or someone else. Rather, this section requires proof that the director believed that the intended result would be an advantage for himself/herself or someone else or causes detriment to the company.

The Court stated that impropriety must be measured objectively. Impropriety will occur when a director granted the company to have a business transaction with a third party in which the director has an interest and fails to disclose it to the company. Adler has breached section 182. Adler took advantage of his position for requesting a $10million loan from HIHC to PEE (a third party company). Furthermore, Williams also breached section 182 by inappropriately using his position as a Chief Executive Director of HIH to gain an advantage for Adler. Williams had caused detriment to HIH and HIHC by authorising the $10 million loan to PEE without ensuring that the proper safeguards were in place.

Improper use of information

Section 183 of the Corporation Act states that a director must not inappropriately utilize the information gain to:

  • achieve an advantage for himself/herself or someone else, or
  • cause detriment to the company

For example, a director is prohibited to use special knowledge, which he or she may has gained because of his or her contact with the stockbroker, to buy shares for him or herself that could have been purchased on behalf of the company.

Furthermore, a director can be liable for breach of section 183 despite no loss being caused to the company. In the case of ASIC v Steve Vizard (2005), Vizard used confidential price sensitive information for his own benefit and he was fined nearly $400,000 and 10 years of disqualification from managing a company.

Criminal Penalties

Section 184 of the Corporations Act states that a reckless or dishonest director who contravenes of sections 181 or 182 or 183 or the entire corporations act leads to:

  • criminal offenses with maximum imprisonment up to 5 years
  • fines of up to $200,000
  • or both

In some cases, directors may be disqualified from the workplace. In ASIC v Adler (2002), Adler was a director of HIH and should act on behalf of HIH. However he advanced for his own financial interests before HIHs interests. The law clearly states that a director must act in honest and in the best interests of the company or shareholders. Adler had contravened serious offenses and displayed lack of commercial morality. Directors are not appointed to take advantage of their own interests, but to govern the company for the benefit of the shareholders. Therefore, Adler was disqualified as a director for 20 years, $900,000 fines and 5 years in prison.

Related party transactions

There are many other statutory provisions in the Corporations Act which have a direct impact on directors, such as prohibiting a company against financial benefits without disclosure.

Under section 208, a company is required to obtain the approval of the members and give the financial benefit within 15 months of the approval if a company wishes to provide a financial benefit to the director or other party. The approval process includes arranging a members meeting and majority passing the resolution. One of the exceptions for this rule is when the transaction is at arms length on ordinary commercial terms, section 210.

In ASIC v Adler, the $10 million was a financial benefit to PEE. However, Adler Corp and Adler contravened section 208 because no disclosure and member approval has been made. Furthermore, the arms length transaction rule (s 210) did not apply to them because the transaction of $10 million was unsecured and undocumented.

Financial Assistance

First of all, financial assistance is not stated under the Corporation Act. Financial assistance can be defined as when a company supports another party to acquire certain shares in its own or holding companies. The most common type of financial assistance is granting of security such as, a fixed & floating charges, over the assets of the company to support the purchaser's financier securing loaned for the purpose of the acquisition.

Under section 260A of the Corporations Act, financial assistance is prohibited unless:

  • it does not materially prejudice the companys interest, its shareholders or the company's ability to pay its creditors, or
  • it is approved by shareholders under section 260B, or
  • it is exempted under section 260C

Therefore, financial assistance that materially prejudices the companys ability to pay its creditors will not breach section 260A because the decision has been carried out under these conditions.

In my opinion, it can be tempting for the directors to make a statement that the financial assistance does not materially prejudice the companys interest. However, directors should resist the temptation to make such a statement. Financial assistance generally put the company in a risky position by putting all of the companys assets to support the other partys interest.

In ASIC v Adler, no disclosure was made to other directors or to the investment committees of lending $10 million to PEE. There was clearly a materially prejudiced in the interest of HIHC, HIH and the shareholders:

  • the $10 million unit trust subscribed by HIHC was worth less than the initial subscription
  • PEE sold HIH shares at a $2 million loss
  • $4 million lost of unlisted shares
  • unsecured loan was provided

As a result, this action materially prejudiced the interest of HIHC, HIH and the shareholders. Thus, section 260A was contravened.

Executive and Non-Executive directors

Executive directors are the full time employees. Executive directors are appointed because of their specialised knowledge and skills of the companys daily operation that the non-executive directors often lack of. On the other hand, the roles of non-executive directors have the duty or obligation to ensure that the board fulfils the company main objectives. The law never implement a rule stating business experience or educational qualification is needed for Non-executive directors. However in the case of Daniels v Anderson (1995), the court sets out minimum standards of care and diligence as a general rule for non-executive directors.

In addition, in ASIC v Rich (2003), the Court stated that Non-executive directors cannot avoid liability by declaring that their duties have a lesser standard compare to executive directors. The standard of care and diligence of a director (Executive or Non-executive) is always objective.

Adler breached section 180(1) because a reasonable and careful person would not permits the $10 million loan to PEE without a proper safeguard applied. Even thought Adler was a non-executive director, executive and Non-executive directors have the same responsibilities under the Corporation Act. All directors, whether executive and non-executive, are required to take reasonable steps to place themselves in a position to work for the best interest of the company.

Conclusion

In conclusion, a company should always ensure it has good corporate governance. Good corporate governance is an essential character of a company. This allows the company to create trust and confidence amongst its members, such as shareholders, directors and all other relevant parties. Good corporate governance increase the companys value and to sustain the company growth. If a company fails to comply the rules under the Corporation Act, the company will be in breach of multiple sections under the Corporation Act.

Furthermore, no law reform was made. Director duties are very important in a company. Directors should not easily got influence by their senior managers and fail in their stewardship. Directors must always familiar with the companys business, such as financial position. Most importantly, as mentioned in Daniels v Anderson (1995), directors, whether executive or non-executive, should always perform their minimum standard of duty.