Prime Trust verdict offers important guiding principles for directors

Recent High Court judgement against the directors of Prime Trust has raised questions regarding ASIC's enforcement conduct, says Professor Pamela Hanrahan.

Amid the coverage of the Hayne Royal Commission’s final stages, some observers may have missed the significant judgement in Australian Securities and Investments Commission v Lewski & Ors [2018] HCA 63 (ASIC v Lewski) that was handed down by the Australian High Court on 13 December 2018.

ASIC v Lewski concerned the actions, from 2006 to 2008, of directors of the responsible entity (RE) of the Prime Retirement and Aged Care Property Trust (Prime Trust), a managed investment scheme registered with the Australian Securities and Investments Commission (ASIC). The directors’ actions resulted in a payment of $33 million — described as a “fee” — to the RE, Australian Property Custodian Holdings P/L, an entity owned by interests associated with Prime Trust director David Lewski, from the assets of Prime following its listing on ASX. The economic benefit of the payment ultimately flowed to Lewski.

In 2013, in the Federal Court, Justice Murphy found that Lewski and the other high-profile directors — Dr Michael Wooldridge, Mark Butler and Kim Jaques — had breached their duties in connection with the payment, and made a pecuniary penalty and disqualification orders against them. In 2016, that decision was overturned by the Full Federal Court. ASIC appealed and the High Court restored most of the original findings against four of the five Prime Trust directors.

The contravening conduct and the circumstances of the appeal are specific to the particular payment transaction and to ASIC’s handling of the resulting enforcement action.

The contravening conduct occurred after (and followed from) a prior amendment to the Prime Trust constitution that purported to provide for significant payments to the RE if Prime Trust was listed or taken over, or the RE was removed.

The amendment was passed by the board of RE without the Prime Trust members’ consent, in circumstances where the board did not have the power to make it. The RE directors’ conduct was governed by specific duties as specified under Chapter 5C of the Corporations Act 2001 (Cth). Adding further complexity to proceedings was the fact that by the time ASIC commenced its action against the directors, the limitation period for any wrongdoing in passing amendment resolution itself had expired.

The Full Court’s decision, in 2016, to allow the directors’ appeal was based on the view that any breach of duty by the directors was spent after the amendment resolution was passed, and therefore ASIC was effectively out of time in bringing proceedings against them. However, the High Court decided otherwise, finding that the steps taken by the board subsequent to passing the amendment resolution (including lodging the amending deed with ASIC and then making the payments to the RE) were a breach of the directors’ duties, including their duties of care and skill, duties of loyalty, duties not to make an improper use of a position, and their specific compliance-related duties as directors of an RE.

Within this complex litigation are important guiding principles for all directors, not just those of REs, and something to be said about enforcement.

Guiding principles for directors

Firstly, the board did not get proper legal advice on the proposed amendment to the constitution and did not take steps to clarify the unsatisfactory advice it received. Lewski dealt with the RE’s solicitors, who were asked to advise on whether the Prime Trust constitution and legislation allowed the amendment to be made by resolution of the board, or instead required consent of the Prime Trust members at a general meeting. This depended on whether the amendment adversely affected their rights as members.

The solicitors said, in essence, the relevant clause of the constitution was open to two possible interpretations, but they did not advise which interpretation of the clause should be preferred and left it to the directors (none of who were legally qualified) to decide which interpretation was correct, and whether they reasonably considered if members’ rights were adversely affected by the amendment.

Given the “highly unusual and equivocal nature of the solicitors’ legal advice”, the High Court agreed with Justice Murphy that “a reasonable person in the position of each director would have obtained clear legal advice, a judicial direction, or members’ approval” for the listing fee payments.

This was part of a broader failure by the directors to give proper consideration to the matter before them for decision — in this case, the impact on the Prime Trust members of lodging the amending deed with ASIC and making the payment. They were negligent at the time they took the steps subsequent to the amendment resolution because, among other things, “there was no consideration of the nature or propriety of the introduction of substantial, additional, effectively gratuitous fees; and the uncertainty deriving from the solicitors’ equivocal advice about the power to make the amendments had not been resolved”.

The directors were also found to have breached their duty to act in the best interests of the members of Prime Trust. The court was careful to point out that duty is “to act in the best interests of members rather than a duty to secure the best outcome for members”.

But the duty is not purely subjective, meaning it is not enough that the directors honestly believed they were acting in the members’ interests. The members’ interests are to be ascertained having regard to the purpose and terms of the scheme, not the success or otherwise of a transaction or other course of action.

The directors were also found to have improperly used their position to provide an advantage to the RE and an indirect advantage to Lewski and others who would benefit from the fees paid to it, and caused detriment to the Prime Trust members. The court confirmed that impropriety “does not depend on an alleged offender’s consciousness of impropriety.

“Impropriety consists in a breach of the standards of conduct that would be expected of a person in the position of the alleged offender by reasonable persons with knowledge of the duties, powers and authority of the position and the circumstances of the case.”

The High Court remitted the case to the Full Federal Court to decide the appropriate civil penalties and disqualifications for directors.

ASIC’s conduct of the enforcement action has been criticised, particularly the delay in commencing proceedings that left it outside the limitation period in respect to the amendment resolution itself. By the time the orders against the directors are finalised, it will be almost 13 years since the contravening conduct occurred. But more broadly, this case sharply illustrates the time, cost and complexity in bringing commercial misconduct proceedings through the civil court system. As the Hayne Royal Commission has made clear, this is a significant factor impacting the efficacy of our regulatory system.