Law Reporter

Professor Bob Baxt provides an overview of recent court decisions affecting the role and responsibility of directors. Many of the matters examined in the Law Reporter are discussed in greater detail in The Baxt Report published by Thomson Publishing.

Canvassing penalty regime for directors – no need for significantly higher penalties

The Honourable Chris Pearce, the Secretary to the Treasurer, in announcing the potential introduction of the Simpler Regulation System Bill (as a flow on from the Banks Report) suggested that there may be a need to increase penalties in the Corporations Act (the Act) for various breaches. Whether such increased penalties are needed or not I will leave to the reader’s judgment. In my view, recent decisions of our courts have indicated a willingness on the part of judges to impose harsher penalties where serious breaches do occur. When HIH collapsed, Santow J imposed significant penalties on Rodney Adler and others for various breaches of the Act. Similarly, harsh penalties have been imposed in other cases where corporations have collapsed, losses have been sustained and directors have breached their duties.

Now, Justice Austin in ASIC v Vines ([2006] NSWSC 760), (judgment delivered on 2 August 2006), has imposed what may be regarded as not insignificant penalties on Vines and others in relation to their contraventions of the Act, arising from the operations of GIO Australia Holdings and related companies. In an earlier note in Company Director (see Early Warner for October 2005), I noted that Austin J found that there had been a number of breaches of the Act committed by Vines and others.

The penalty judgement involving Vines and others is very interesting – the judgment (a lengthy one of 64 pages) canvasses a range of options available to the judge in considering what penalties to impose. These range from disqualification orders, to imposing pecuniary penalties of up to $200,000 and orders for costs. In dealing with the particular application before him in this matter, Austin J discussed section 1317EA of the Act which sets out a regime involving disqualification orders that may be imposed on a director where the court finds that the person is not a fit and proper person to manage a corporation, as well as dealing with penalties.

Interpreting the principles – general comments

In concluding that a significant penalty should be imposed on Vines, Austin J offered these thoughts on the meaning of the provision and how it should be interpreted in the context of disqualification of directors in particular:

“In my opinion, the words ‘manage a corporation’ [in the section] refers to the management of corporations generally, not the particular corporation in respect of which the offence occurred, nor any particular subgroup of corporate business activity. It is directed to the overall suitability of the defendant to continue to engage in business management activities in the corporate sphere, encompassing both listed public corporations and unlisted corporate entities. Consequently, a defendant may be a fit and proper person to manage a corporation although the court has concluded that the defendant: is not a fit and proper person to continue to manage the corporation in respect of which the contraventions occurred …” (at para 15)

Austin J noted that the question that he had to consider is “whether any deficiency or inadequacy relates to the relevant overall suitability of the defendant to engage in business management activities in the corporate sphere” (at para 16).

He posed a couple of interesting examples which are worth repeating:

“[A] finding that a defendant occupying an executive position persistently failed to inform the board of directors of information that the board needed in order to perform its duties might raise a question about that defendant’s appreciation of the function of the board of directors of a corporation or willingness to play his or her part in effective corporate governance. Depending on the circumstances, that may be a sufficient basis for the court to conclude that the person was not a fit and proper person to ‘manage a corporation’, even though the deficiency … would be irrelevant to management of certain kinds of corporations …” (at para 16)

He then considered the relevance of the information before him – he was dealing here with a listed public company. In his opinion, a finding of deficiency or inadequacy suggesting a failure to appreciate “or an unwillingness” to contribute to aspects of corporate governance that are peculiar to listed companies (for example, the continuous disclosure obligations) [may] also mean that the defendant is not a fit and proper person to ‘manage a corporation’ even though the matter concerned has no relevance except for listed companies. In such a case, a basis for the conclusion that the defendant is not fit and proper to manage any listed corporation is enough to prevent the court from being satisfied that the defendant is fit and proper to manage corporations generally.” (at para 17)

Pecuniary penalty orders were sought against the relevant defendants. The provisions in the legislation are apparently considered strict in that regard – the court shall not make an order imposing a penalty unless the contravention is a serious one. Austin J discussed the relevant authorities and then considered the evidence.

ASIC argued that the serious nature of the contraventions would, if an appropriate penalty was imposed, send a signal to the community that the corporate structure should not be used in a manner contrary to commercial standards. Austin J accepted this proposition. In the circumstances, although Austin J recognised that it was important to keep things in balance (having regard in particular to the positive arguments made on behalf of Vines), he also believed it was important “for the court to convey by its orders its view of the nature and seriousness of the contraventions so as to achieve a deterrent effect. Although the need for personal deterrence is not pressing in the present case, because of Mr Vines’ contrition, I have decided that personal deterrence should still be an objective of the orders, given there is some prospect that he might return to a senior executive position in future or be appointed to non-executive directorships.” (at para 111)

Austin J made additional observations about the penalty in the context of the evidence in this case.

“In the present case it seems to me that Mr Vines’ contraventions, individually and taken together, are serious. [They relate] to the need for senior management to take care to provide the board of directors with material information necessary for them to discharge their duties … Mr Vines’ duty was to take care to ensure that monitoring arrangements were operating at the divisional level so that information was identified, as it arose, that might need to be disclosed to the market, so that the parent company and its directors could discharge their obligations under the continuous disclosure requirements of the stock exchange listing rules and under the [legislation]” (at para 119).

Disqualification orders – some further observations

I have discussed the criteria adopted by the courts on previous occasions in this journal and it is unnecessary to repeat them. After reviewing the evidence in this case, Justice Austin made a number of rulings against Vines. He felt that a disqualification order was warranted and that while there was no evidence that Vines was acting dishonestly, the arguments put forward on his behalf did not preclude the court ruling that there had been a failure on his part to act with “due care and diligence to make complete and accurate disclosure to the board … [The relevant contraventions did not arise] out of failure to undertake some additional investigations or failure to obtain some additional investigations [nor were they …] contraventions that might plausibly be mitigated by reference to extreme workload and pressure” (at para 101). Austin J held that by defending his case, Vines was not doing anything inappropriate or wrong – that was a course of action he was entitled to pursue. Furthermore, while Justice Austin said he could not find any strong arguments that significant losses may have been sustained, nevertheless there was evidence that there may have been losses relating to the failure on the part of the defendant.

So how did Justice Austin sum up the evidence before him?

“186. The first question to consider, bearing in mind these competing considerations, is whether the court should make a disqualification order against Mr Vines. The case law shows that such an order may be justified by the need to protect the public from misuse of the corporate structure, and considerations of personal and general deterrence and retribution. … I am not satisfied, on the evidence before me now, that Mr Vines is a fit and proper person to manage a corporation. That being so, protection of the public and personal deterrence are relevant considerations, although their weight is lessened [by certain acts of contrition and good work by Mr Vines].

187. In my view general deterrence and retribution are important considerations in the present case. Mr Vines is part of a class of senior managers of major Australian public companies, executives who report to the chief executive, or some other officer of the most senior level, or direct to the board. They have very substantial power within the corporation, are under minimal day-to-day supervision, and are exposed to a great deal of pressure as well as financial incentives to contribute to the company’s success. Senior executives, like executive directors, are ‘sensitive to risk’ to use Finkelstein J’s description in Vizard …

188. Making a disqualification order in the case of Mr Vines will make it clear that there is a substantial prospect that serious consequences will be visited on senior executives who, by a failure to act with due care and diligence, risk leaving their boards uninformed on material matters known to management. It would obviously not be appropriate to sacrifice any defendant to the perceived public interest by making orders disproportionate to the defendant’s contraventions, but where the contraventions are serious, as they are in the case of Mr Vines, the objectives of general deterrence and retribution point against any substantial discounting of penalties.”

Conclusions

In essence Austin J felt that not only should there be a period of disqualification imposed, but penalties should be imposed as I have noted previously. The decision is a sobering reminder of the impact that serious breaches of the Act may have on individuals, especially individuals who have a good reputation in the community and who have important professional qualifications and experience to offer the community. When courts act sternly in such cases they send a clear indication that our system does work. We do not need significantly higher penalties being introduced for breaches as the basic provisions of the corporations legislation are adequate as they stand. Where fraud or crime is involved then of course we are talking about a different scenario altogether. That is certainly not the case here.

We should hasten slowly to increase the penalty regime currently operating – rather we should ensure that ASIC has the resources to pursue these cases where appropriate.

Another flaw in the Trade Practices Act – Government dealings outside the reach of the Act

When the Commonwealth and State Governments agreed in 1995 (after the Hilmer Report) that the Trade Practices Act (the Act) (which generally prohibits anti-competitive conduct as well as certain unfair conduct) should be extended to all parts of the Australian economy, one or two exceptions remained. The intention of the legislation was to ensure that only to a very limited extent would the Act not apply across the board to all parts of commercial activity. The professions were brought within the ambit of the legislation; significant changes were made to section 2 of the Act to ensure that activities on the part of government bodies engaging in trade and commerce would be covered; and other changes were introduced to open up essential facilities (such as infrastructure) to access under particular provisions of the Act. However, as appears from a recent case, an important immunity still exists in relation to contracts etc entered into by government instrumentalities which do not engage in business in the context of their activities. This was the view of the Full Federal Court in ACCC v Baxter Health Care Pty Ltd ([2006] FCAFC 128.

The full court ruled that the High Court decision in Bradken Consolidated Limited v Broken Hill Proprietary Company Limited ((1979) 145 CLR 107) would still apply so that Crown immunity (that is the non application of the Act) would immunise contracts entered into by Crown instrumentalities with private organisations.

In this case the issue was whether certain contracts entered into by Baxter Health Care with the various health authorities of New South Wales, Queensland, South Australia, Western Australia and the Australian Capital Territory breached both section 46 and section 47 of the Act. Section 46 prohibits companies, which have market power, from misusing that power, while section 47 prohibits companies entering into arrangements or agreements which have the purpose or effect of substantially lessening competition. In response to tenders from the relevant health authorities, Baxter Health Care agreed to supply sterile fluids (in which it had arguably monopoly power) with certain other products to the relevant authorities in a manner which it was alleged by the ACCC eliminated competition in the market. At first instance, Justice Allsop held that certain of the arrangements did breach sections 46 and 47 of the Act; but by virtue of the operation of Bradken’s case, the Act did not apply to the arrangements/agreements so that Baxter Health Care could not be said to have breached the Act.

Justice Allsop indicated that the Bradken case applied in this instance notwithstanding the legislative amendments that had been made in 1995, and notwithstanding the fact that the High Court of Australia in Northern Territory Power Generation Pty Ltd v Power and Water Authority (2004) 219 CLR 90 had interpreted the amendments to the Act in 1995 in an expansive way. This was illustrated by the High Court dismissing a claim by the defendant in the Northern Territory Power case, that it was entitled to Crown immunity from the operation of the Act. Allsop J ruled that, regrettably for the ACCC in the Baxter case, the Bradken principle still applied. The Bradken principle was described by Justice Allsop (and the Full Federal Court) to cover the following situation:

“The principle applies to proprietary, contractual and other legal rights and interests such that it can be said that there is an impairment of the existing legal situation of the Crown.

If a State or Territory has a contract with a non-government party, the [Trade Practices Act] is to be construed as not applying to that contract such that the State or Territory and non-government party [are] not bound by the terms of the [Trade Practices Act] in relation to the entry into and performance of that contract.” (See Baxter at para 70)

The Bradken case is an interesting one. It arose out of the acquisition by the Minister for Railways of Queensland of certain railway stock in connection with the development of the new railway line. Bradken Consolidated Limited and another company were suppliers of railway stock and alleged that there had been contracts entered into between the Minister for Railways and another company (BHP Ltd) which were in breach of section 45 of the Act. They also alleged a breach of section 47 of the Act. The High Court ruled that because the contracts were with an instrumentality of the Crown, and at the time the Act did not apply to the Crown, claims under the Act could not be made against a private party even if it acted in breach of the Act. The fact that the contract was with the Crown meant that the Act did not apply to the contract.

It is likely that the ACCC will appeal this decision to the High Court of Australia. In the meantime, perhaps the Commonwealth Government should move more quickly and amend the law as to make it clear that the Bradken principle should no longer immunise contracts between government agencies and private parties where the Act is breached.