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Alan Kohler is one of Australia’s most experienced commentators and journalists. Alan is the founder of Eureka Report, Australia’s most successful investment newsletter, and Business Spectator, a 24-hour free business news and commentary website. He also hosts Inside Business, a half-hour Sunday programme on the ABC, is the finance presenter on the ABC News - and producer of the nightly graph (or two).
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Balancing the scales on Centro

Jennifer Hill & Robert Austin6 Sep 2011, 4:04 PM

There's a discrepancy between the decisive judgment and the severity of penalties handed down in the recent Centro case. But that doesn't necessarily mean they got off lightly.

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The Federal Court ruling in the Centro Properties Group case in June has been viewed by many as significantly raising the legal bar in relation to Australian company directors' duty of care.

Yet the penalties imposed on Centro’s executives and directors last week were described by some media commentators as too lenient.

How can we explain this apparent gap in severity between judgment and the penalty? A close examination of Justice John Middleton’s judgments in this case provides some answers.

In proceedings brought against Centro’s directors and financial officer, the Australian Securities and Investments Commission alleged that the directors had breached their duty of care and diligence – and their duty to ensure compliance with financial reporting laws – by failing to detect major errors in Centro’s financial statements.

Justice Middleton agreed, and ruled that the directors failed to exercise due care and diligence.

But while the liability judgment found that the managing director and non-executive directors had all breached their duties of care and diligence, the recent penalty judgment distinguishes between them in terms of the penalty outcomes of those contraventions.

In the penalty judgment, Justice Middleton made detailed declarations of contravention against all defendants, and imposed a fine of $30,000 on Centro’s former chief executive officer, Andrew Scott.

A two-year management disqualification order on former chief financial officer Romano Nenna was made on the basis that he had admitted the contraventions alleged against him and had submitted that the appropriate order would be disqualification for up to two years.

Interestingly, however, no orders were made against the six non-executive directors of Centro.

Corporate law provides a number of potential safe havens, which may enable directors to escape liability for breach of the duty of care and diligence.

In certain circumstances, for example, directors may be exonerated by claiming that they had delegated certain responsibilities. The ‘business judgment’ rule may also, in some circumstances, provide directors with protection against liability – as demonstrated in the 2009 decision in ASIC’s case against former executives at collapsed telco One.Tel.

Once the court determines that directors have breached their duties of care and diligence, the focus will shift to a different set of safe havens, which can mitigate the consequences of breach.

These safe havens include exoneration provisions in the Corporations Act, which assumed centre stage in the Centro penalty proceedings.

These provisions grant the court power to excuse a person from breach where the person acted honestly, and where, having regard to all the circumstances, ought to be excused.

These provisions are classic ‘mud’ (as opposed to ‘crystal’) rules, in that they are vague and open-ended, and allow for considerable judicial discretion in assessing specific factual and contextual matters.

Justice Middleton could have decided that Centro’s non-executive directors were exonerated from liability by virtue of these two provisions. Yet he did not.

Rather, he held that the non-executive directors had contravened the Corporations Act, and accordingly, the court should make declarations of contravention, but that no further penalty would be imposed upon them.

Justice Middleton’s decision concerning the exoneration sections of the Act is consistent with the general judicial trend to date.

Australian courts, in spite of the breadth of judicial discretion, have not been particularly generous in their interpretation of these exoneration provisions, often on the basis that the granting of relief would be contrary to public policy and the goal of encouraging directors to comply with their duties.

One recent exception to this trend was the decision in The Stake Man Pty Ltd v Carroll, where the court exonerated a director for contravention of the insolvent trading provisions of the Corporations Act, on the basis that he had acted honestly and reasonably relied on a third party’s assessment of the company’s financial position.

Justice Middleton justified his decision not to exonerate the directors in the Centro case on discretionary grounds, principally relating to the seriousness of the contraventions.

He held that declarations of contravention, without disqualification or pecuniary penalty orders, were sufficient "to indicate the court’s disapproval of the actions of each of the defendants, and satisfy the principle of general deterrence”. Also, he considered a range of factors to "militate very strongly against excessive penalties”.

Justice Middleton’s approach in regard to penalties may appear puzzling, in the light of some strong statements in his earlier judgment about the extent to which directors can be protected by reliance on others.

The liability judgment, for example, stressed the fact that reliance on the financial staff and auditors did not protect the directors from liability because of their failure to make an independent assessment in light of what they knew about the maturity profile of the group’s debt.

In the penalty judgment, on the other hand, a factor influencing the judge towards leniency was that "the non-executive directors reasonably expected that the accounts produced by the accounting staff of the Centro Group would comply” with the relevant financial reporting standards.

What can explain the apparent tension between the liability and the penalty judgment in this regard?

One explanation is the distinction between aspirational and legal standards of corporate governance.

In the United States, in the famous (or perhaps, notorious) Disney decision, Chancellor Chandler stressed that although the defendant directors’ conduct fell well short of the ‘aspirational’ standards of corporate governance, these standards were not co-extensive with legally enforceable fiduciary duties.

By way of contrast, Justice Middleton did take such aspirational matters into account in determining that Centro’s directors had contravened their duty of care by failing to "apply their minds” and exercise independent judgment in relation to the company’s financial accounts.

However, at the penalty stage, the judge was prepared to consider a broader range of matters in the exercise of his discretion, such as the fact that Centro’s directors were "intelligent, experienced and conscientious people”.

The judge also took the view that there was a reduced need to impose penalties for reasons of general deterrence, in view of the damage that the directors had already experienced to their reputations.

It would be unwise to regard the penalty judgment as somehow negating the force of the liability judgment.

Putting the two judgments together, the case shows that there are shades of difference in the principles to be applied at the liability and penalty stages of a trial. In that respect, the Centro case is well in line with previous authorities.

This story first appeared on The Conversation. Reproduced with permission.

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