The implications of Centro decision to Tractors and Trucks
The Centro decision puts limits to the extent to which the directors of Tractors and Trucks can rely on external advisers and on the management while approving financial statements. The decision reinforces the fact that directors need to demonstrate a high degree of financial literacy, which they should extend as far as conventional accounting practices and basic accounting concepts are concerned. Further, if the directors of Tractors and Trucks Ltd notice any error in draft financial statements brought to them for approval, they must question the management or the external advisors before making any approval.
Recent reforms on responsibilities and knowledge of non executive directors
According to Harrisch, a non-executive status does not give leeway to perform duties at a lesser standard than the executive status. Rather, under the amended Corporations Act 2001 (Cth), all directors are obligated to provide standard care regardless of whether one is an executive or a non-executive director. Therefore, all non-executive directors (like the executive directors) owe the basic obligation of monitoring the affairs of the company by maintaining high levels of awareness of the company’s activities and financial status. As Harrisch asserts, “such knowledge is a necessary component of the director’s appraisal of and agreement to the company’s annual reporting requirements.”
Relevant law
Various changes were made to Corporations Act 2001 (Cth), leading to introduction of the new rules. The first change involved subsections 250R (2), and 250V (1) and section 250U of the act which introduces first ‘two strike’ rule. Sections 206K, 206L and 206M require listed companies to declare the use of remuneration consultants. Section 250R (4)-(10) prohibits key management personnel and also their closely related parties from voting on a spill resolution.
The decision held by the federal court in the Centro case was in accordance with section 344 (1) of the Corporations Act 2001 (Cth), which provides that directors should take all necessary steps to ensure compliance with, or to comply with the financial reporting obligations stipulated by the Act. In addition, the omissions were in violation of sections180 (1) and 601FD (1) (b) of the Act which require directors and other officers in governance to demonstrate a high degree of care and diligence in making approval to statements or reports of a company. In the Fortescue case, the federal court established that FMG contravened section 674(2) of the Corporations Act which stipulates that public companies should notify the market of any information that is not generally available for disclosure. In addition, the company contravened section 1041H which prohibits an individual or a company from engaging in deceptive or misleading conduct in relation to a financial service or product.
Conclusion
In conclusion, the recent reforms to the Corporations Act 2001 (Cth) have led to increased corporate credibility and transparency in the process of executive remuneration. In addition, under the amended Act, all directors owe the duty to be responsible and to maintain high level of awareness of the company’s activities and financial status. As noted in the above argument, the Centro and Fortescue decisions demonstrate that directors can establish and supervise processes within companies but unavoidably, they are part of the process and thus, still have an obligation to exercise reasonable care and diligence. The decisions held in both cases send a clear message to Tractors and Trucks Ltd regarding the importance of the fundamental legal requirement that financial statements and reports must present fair information with high regard to their impact on the decisions of the users, especially the shareholders.
References
Austin and Black, (2011), Division 1 - General duties [ss 180–190B]: officers and employees [Accessed 15 august 2011] http://www.lexisnexis.com.au/pdf/austin-black-sample-annotation_s180.pdf
Australian Securities Exchange (ASX), (2004) Principle 4: Safeguard integrity in financial reporting, [Accessed 15 august 2011] http://asx.ice4.interactiveinvestor.com.au/ASX0701/Corporate%20Governance%20Principles/EN/pdf_pages/page_0027.pdf
Australian Securities Exchange (ASX), (2010), Corporate Governance Council, Corporate Governance Principles and Recommendations (2nd ed. 2007), [Accessed 15 august 2011] http://www.asx.net.au/documents/about/cg_principles_recommendations_with_2010_amendments.pdf
Comino, V, (not dated), The Challenge of Corporate Law Enforcement in Australia, [Accessed 15 august 2011],
Commonwealth Consolidated Acts, (2001) Corporations Act 2001, [Accessed 15 august 2011]
Commonwealth of Australia (1998), Corporate Law Economic Reform Program, Paper No. 3 (Directors’ Duties and Corporate Governance: Facilitating Innovation and Protecting Investors, 1997 [Accessed 15 august 2011]
Constitution of the Registered Company, (not dated), [Accessed 15 august 2011] http://www.oup.com/uk/orc/bin/qanda/sample_chapters/judge_ch02.pdf
Deringer F. B, (2004) Directors’ duties in a group Situation, [Accessed 15 august 2011]
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Federal Court of Australia, (2011), Australian Securities and Investments Commission v Fortescue Metals Group Ltd [2011] FCAFC 19 (18 February 2011), [Accessed 15 August 2011] http://www.austlii.edu.au/au/cases/cth/FCAFC/2011/19.htm
Fletcher, G., (2011), ASIC v Fortescue Metals Group Ltd [2011] FCAFC 19, [Accessed 15 August 2011] http://www.bransgroves.com.au/corporations/asic-v-fortescue-metals-group-2011-fcafc-19.html
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Letter of advice to Tractor and Trucks Ltd
Shyna Chow
Lawyers and Notaries
131 Wellington Road
VIC 3113
Ph +61433932206
Email: [email protected]
Name of Director
Director
Tractor and Trucks Ltd.
Address
Dear Sir/ Madam,
Re: The possible legal ramifications of a recent decision of the board
Facts
The recent decision of the board of Tractors and Trucks Ltd involves a breach on fiduciary obligations by the directors and the Technical Manager, Mr. Alphonse Pennyweather. The non-executive directors approved a $2 million payment to Jian Fu Tractors Ltd, a Chinese registered company to supply spare parts to Tractors to Tractors and Trucks Ltd without critically scrutinizing the merits of the contract. This was in response to a recommendation by Mr. Alphonse Pennyweather, the Technical Manager of Tractors and Trucks Ltd, who had received an ex-gratia payment of US$250, 000 from the Chinese registered company to push the proposal through for the board to recommend it. Given that this took place after the Centro (ASIC v Healey & Ors [2011] FCA 717) decision, the decision of the board of Tractors and Trucks Ltd has possible regal ramifications to the board and to Mr. Pennyweather.
Legal issue
Two legal issues arise in this case. The first pertains to the possible legal liability of the non-executive directors concerning their move to approve the proposal at face value. A second issue which is evident in this case concerns the potential regal liabilities of Mr. Pennyweather under the aforementioned circumstances.
Regarding the possible legal liability of the non-executive directors, Tractors and Trucks Ltd need to understand that the non-executive owe fiduciary duty to demonstrate care and diligence in their work similar to the standard required of the executive directors as provided for under the Corporations Act 2001 (Cth). Further, the Act provides that company directors should make independent and informed assessment in the context of the director’s position and the complexities of a company’s operations before approving financial statements. In this case, the non-executive directors relied on the judgement of the Technical Manager, Mr. Alphonse Pennyweather and approved the recommended proposal at face value. This explains the fact the non-executive directors of Tractors and Trucks Ltd breached the law of fiduciary obligations by approving the contract at face value.
Similarly, Mr. Pennyweather’s engagement clearly contravened the law of fiduciary obligations embodied in the amended Corporations Act 2001. This law provides that the key management personnel have a fiduciary duty to avoid engagements that may result into conflict of one’s interest and with the interests of those that one is bound to protect. In this case, the Technical Manager of Tractors and Trucks Ltd Mr. Pennyweather received an ex-gratia payment of US $ 250, 000 from Jian Fu Tractors Ltd in order to put forward the proposal and recommend it to the board. That way, he intended to make an undisclosed profit out of the company’s dealings. In this regard, it would be appropriate to say that Mr. Pennyweather contravened the law of fiduciary obligations.
Application of law to facts
Several laws are applicable to this case. To start with, sections 181 of the amended Corporations Act 2001 (Cth) stipulate that all officers of a company owe the fiduciary duty to demonstrate care and diligence in their dealings with company matters. This section is relevant to the actions of the non-executive directors who demonstrated lack of care and diligence while approving the proposal by the technical manager. On the other hand, Section 183 of the act stipulates that an officer or an employee of a company must not use their positions improperly so as to gain profit themselves or to damage the company. The engagement by Mr. Pennyweather violated this rule since it leads to a conflict of interest between him and Tractors and Trucks Ltd.
Conclusion and options
In conclusion, the move by the non-executive directors of Tractors and Trucks Ltd the $2 million to approve the contract with Chinese registered company, Jian Fu Tractors Ltd amounted to violation of fiduciary duty of care and diligence provided for under the Corporations Act 2001 (Cth). By approving the proposal from the technical manager without checking its merits, the directors violated the principle that they ought to make informed judgement based independent and informed assessment of the proposal. Mr. Pennyweather also violated the law of fiduciary obligations by acting in self-interest at the expense of the company.
Recommendations
The only option of Tractors and Trucks Ltd is to find the best remedy to the issue as provided for under the fiduciary law. In this case, one of the best remedies would involve rescission of the contract. Another option is to hold the non-executive directors liable make compensation to the company should any damage arise from this contract. Regarding Mr. Pennyweather, Tractors and Trucks Ltd has an option to strip him of the secret payment from the Chinese company regardless of whether the company makes profits or losses.
Yours sincerely,
Shyna Chow
Parliament of Australia, (Explanatory Memorandum, Company Law Review Act, 1998) (Cth) [Accessed 15 august 2011] http://www.aph.gov.au/library/pubs/bd/1997-98/98bd133.htm
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Thomsons Lawyers, (Corporate alert, A director’s duty to review accounts – the Centro decision, 2011) [Accessed 15 august 2011] http://www.thomsonslawyers.com.au/awms/Upload/Files/publications/2011/Corporate%20Alert%20-%20A%20director%27s%20duty%20to%20review%20accounts%20-%20the%20Centro%20decision%20July%202011.pdf
A B Leibler (The Centro decision: ASIC v Healey, 2011) [Accessed 15 august 2011]
Federal Court of Australia, (Australian Securities and Investments Commission v Fortescue Metals Group Ltd) [2011] FCAFC 19 (18 February 2011), [Accessed 15 August 2011]http://www.austlii.edu.au/au/cases/cth/FCAFC/2011/19.html
A B Leibler, (ASIC wins in Fortescue Metals appeal: Clarity on interpreting continuous disclosure requirements under the Corporations Act, 2011) [Accessed 15 August 2011]
A B Leibler (The Centro decision: ASIC v Healey, 2011) [Accessed 15 August 2011]
J Lowry, “The Recognition of Directors Owing Fiduciary Duties to Creditors – RePantone 485 Ltd and Colin Gwyer & Associates Ltd v London Wharf (Limehouse) Ltd,” (International Corporate Rescue Journal, 2004)1(1), [Accessed 16 August 2011]
Australian Securities Exchange (ASX), (Corporate Governance Council, Corporate Governance Principles and Recommendations (2nd ed. 2007), [Accessed 15 august 2011] http://www.asx.net.au/documents/about/cg_principles_recommendations_with_2010_amendments.pdf
A Downie, (The Centro matter: ASIC v Healey [2011] FCA 717 and breach of director's duties, 2011) [Accessed 15 august 2011]
A B Leibler (The Centro decision: ASIC v Healey, 2011) [Accessed 15 august 2011]
Harrisch, (Australian corporate law: Director’s and officer’s duties, 2009)[Accessed 15 august 2011]
Parliament of Australia, Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (2011) [Accessed 15 August 2011]
J G Hill, “Regulatory Responses to Global Corporate Scandals,” (Wisconsin International Law Journal 23( 3): 394.
Commonwealth Consolidated Acts, (Corporations Act 2001, 2001) [Accessed 15 August 2011]
A B Leibler (The Centro decision: ASIC v Healey, 2011) [Accessed 15 august 2011]
Commonwealth Consolidated Acts, (Corporations Act 2001, 2001) [Accessed 15 August 2011]
