An Overview of the Directors’ Duties and Responsibilities Breached in the Centro Case

Discuss about the Centro Case for Duties and Responsibilities Outlined.

In 2011, the Federal Court of Australia ruled on Australian Securities & Investments Commission (ASIC) v Healey & Ors [2011] FCA 717 (the Centro Case), which has become one of the landmark cases on the duties and responsibilities of Australian company directors with regard to financial statement (Bowlt, 2011). As the facts of the case go, ASIC had instituted civil proceedings in 2009 against directors and officers of the Centro Group citing breach of the statutory duty of care, skill and diligence (McCullough Robertson Lawyers, 2011). According to ASIC, the directors were liable in breach as they had approved financial statements in 2007 which were marred by discrepancies.  Additionally, the court had to address the issue of delegation of the aforementioned duty, the duty of directors to take reasonable steps in ensuring financial statements adhere to financial reporting standards as well as the role of non-executive directors in management (AICD, 2011). The issues in question were contraventions of ss. 180(1), 601FD (1) and 344(1) of the Corporations Act 2001(Cth), hereinafter referred to as the Act 2001. The following report is commissioned to outline the specific duties and responsibilities breached by the Centro Group directors and analyse the Court’s decision in view of the Act 2001.

The Act 2001, s.180, expects that directors execute their duties with a certain level of care, skill and diligence as would a prudent man under similar circumstances (Latimer, 2012, p. 698). This provision is adopted from the common law standing as illustrated by Romer J in Re City Equitable Fire Insurance Co Ltd [1925] Ch 407, where the standard of care in this duty is pit against the actions of a prudent man in the same situation (Corkery, 1987, p. 133). However, today the test also takes into consideration the nature of the business in question, its size, the constitution of the board of directors and the allocation of duties amongst them  (Douglas, 2015).

Additionally, the Act 2001, under s 198D, gives directors powers to delegate their duties so long as this is in line with the company’s constitution. These duties include the preparation of company accounts, management roles among others. The delegation, however, does not exclude directors from keeping track of company activities, they cannot simply rely on the information of experts or employees but should undertake to examine and clarify details pertaining to their duties (Douglas, 2015). In ASIC v Macdonald (No 11) [2009] NSWSC 287 (the James Hardie case), Gzell J, even where expert advice is sort or duties are delegated, directors have a nondelegable duty to the company and its stakeholders to ensure they take all reasonable steps to provide accurate information failure to which they will be in breach of s180 of the Act 2001 (Wan, 2015, p. 79).

The Duty of Care, Skill and Diligence

In the Centro case, the directors breached the duty of care, skill and diligence by failing to identify the discrepancy in the company’s financial statements; the actions of the directors, in this case, fell below the stipulated standard of care mentioned above (Paolini, 2014, p. 314). Additionally, the directors’ reliance on external advisors, that is the PWC auditors, did not suffice as a reason to exempt them from liability as the law expected them to take all necessary action to ensure accuracy despite delegation of duties (Basovo, 2012, p. 84). The failure to identify the inaccuracies, as well as investigate the information provided by advisors, led to a breach of duty by Centro Group’s directors.

The Act 2001, under s.295 (4), tasks directors with the duty of making a declaration on the company’s financial position. In making this declaration, directors are required to ensure the information they provide is accurate and a true and fair view of the company’s position; this means that they are expected to read and understand said statements and apply their knowledge while reviewing them (AICD, 2011). Additionally, ss 601FD (1) and 344 (1) place the duty on company directors to take proper measure to ensure they, as well as the company, comply with the provisions of the Act 2001. The onus is therefore on directors to stay in the loop and pay attention all while ensuring utmost competency among board members so as to avoid discrepancies (Worthington, 2016, p. 382).  Failure to comply with this requirement attracts a civil penalty on offenders who are found liable.

According to Owen J in The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239, the buck of responsibility and liability in the running of a company stops at the board of directors. As such, directors have the duty to fully comprehend their duties and take all necessary measure to comply with them (Schenone, 2011, p. 95). The delegation of duties does not make them dormant; they must create for themselves a working knowledge on the running of the company and apply their mind to any information received from management (Daniels v Anderson, 1995). Directors are at the apex of the corporate structure and although they do not need to be involved with the nitty gritty details of the company’s day to day operations, case law is clear that they have a principle role to play in the management of the company and as such should always be aware of the fundamentals of the business (AICD, 2011).

Duty not to Make Misleading Statements

In the Centro case, the Directors relied on the external auditors’ findings that there were no discrepancies in the financial statements. Although these were well renown auditors, the law expects directors to take it upon themselves to ensure their declarations are not misleading and reflect a true and fair view of the institution’s financial position. It is clear that the Director’s, in this case, did not intend to mislead stakeholders but merely relied on misleading information, however, failure to utilise their knowledge and adequately review the records constituted a breach of duty by Centro’s directors.

In the Centro case decision of June 2011, Justice Middleton found that each of the directors knew of the current interest bearing liabilities and guarantees and in addition knew, or should have known, of the key accounting principles that would inform them of any discrepancies in the statements (AICD, 2011). As such, each director did not take reasonable steps or apply his mind accordingly; additionally, they all failed to question management and other relevant parties on the proposed statements and additionally failed to request declarations as per the provisions of s 295A of the Act 2001.All these are duties expected of them in their capacity as directors and failure to fulfil them constituted a breach of the duty of care skill and diligence owed to Centro Group and a failure to take prudent steps in ensuring financial statements comply with set guidelines (AICD, 2011). They had, therefore, contravened the provisions of ss 180(1), 601FD (3) and 344 of the Act 2001. The following discourse will analyse the court’s decision, in depth, in view of the Act 2011.

According to Justice Middleton, directors must read the financial records and formulate their own view and not simply rely on the information provided by experts and advisors before approval (McCullough Robertson Lawyers, 2011). He believes that reading and comprehending the contents of the statements personally requires that the director to question whether the proposed statements are in line with his personal knowledge of the company’s financial position. In his decision, the judge expressed that directors ensure they have a basic understanding of the company’s business and its fundamentals. In addition, company directors must remain informed on company activities and monitor their affairs and policies by familiarising themselves with its financial status and conducting routine reviews of its statements (McCullough Robertson Lawyers, 2011). This is in line with the provisions of ss 601FD(1) and 344(1) of the Act 2001, which task directors with ensuring they take undertake measures to ascertain compliance with set guidelines in the Act 2001. Each director should have taken it upon themselves therefore to have an interest in the information provided by the external auditors and apply their skill as directors to discern the accuracy of the information provided.

An Analysis of the Court’s Decision in View of the Corporations Act 2001

The decision in the Centro Case illuminates the higher standard of care expected of directors as opposed to previous cases. The original test for the standard of care as illustrated in Re City Equitable Fire Insurance was said to be subjective. The test in Centro, guided by s 180 of the Act, encompasses both the subjective and objective test where directors’ duty of care is pitted against the actions of a prudent man as well as their specific skill; where a director is appointed based on a particular skill the duty of care expected of them is higher (Wan, 2015). As such, the directors were not only expected to act diligently but also to apply their knowledge of the company’s business in their review of its statements as they had been appointed with the expectation to nurture this skill. Their failure to apply this knowledge led the court to find them liable for breach of duty based on the aforementioned subjective and objective tests.

Additionally, the decision in Centro outlined the extent to which directors can delegate their duties as per section 198D. This issue intertwined with the aforementioned issue of reliance on professional information. In Centro, a committee of directors known as the ‘board audit and risk management committee’ had been commissioned with the mandate to supervise the preparation of financial statements and reports (AICD, 2011). Justice Middleton held that, although an audit committee played a significant role it could not substitute the role of directors. This decision puts a limit on the extent to which directors can delegate their duties as well as the significance of their managerial role to the company. Justice Middleton believed directors were paramount to the company structure and should not assume their duties through delegation (Schenone, 2011).

Critics note, however, that this decision has failed to provide directors with the guidance on how much enquiry they are to make on proposed financial statements (McCullough Robertson Lawyers, 2011). The directors may experience challenges in identifying how far they are to investigate issues that are not clearly identifiable on information provided by management. Additionally, there is the fear that the decision, in this case, could challenge the relationship between management and directors as the high standard of care requires directors to heighten their scrutiny of information brought before them (Norton Rose Fulbright, 2011). This poses a challenge as the decision was unclear on the extent to which it is appropriate to scrutinise information and records presented to directors (McCullough Robertson Lawyers, 2011).

Conclusion

As illustrated in ASIC v Healey & Ors (2011), the Corporations Acts (2001) (Cth) s 180 places a duty on directors to exercise care, skill and diligence in their responsibilities. Additionally, directors are expected to take all necessary measure to ensure the company’s financial statements comply with financial reporting standards as per ss 601FD (1) and 344 (1) of the Act. In the above-mentioned case, the company directors failed to identify discrepancies in their annual financial reports after relying on professional experts who found no corrections in them. Their failure to identify these discrepancies constituted a breach of the aforementioned duties as they were expected to apply their knowledge and skill to review the reports prior to approving them. The decision of the Federal Court had brought with it some challenges as it remains unclear as to how much scrutiny directors should exercise on the information availed to them by management and additionally on how liable they are where they fail to identify mistakes that are obvious. With this in mind, it is clear that directors, although given the power to delegate, should remain at the apex of the corporate structure and exercise care, skill and diligence in reviewing financial statements so as to ensure they reflect a true and fair view of the company’s financial status.  

References

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