Directors’ Duties – “Should we?” – the High Court says “NO” in ASIC v Lewski

Highlights

APRA’s 2018 review¹ into CBA’s corporate governance practices recommended injecting into CBA’s DNA a “should we?” question in relation to all dealings with and decisions on customers.

The High Court expressed a similar sentiment in its recent decision in ASIC v Lewski,² where the court looked at numerous board decisions of the responsible entity of retirement village operator Prime Trust in the lead up to its collapse in 2011, and found that a reasonable director in the position of the directors would not have done what the directors did.

Commenting on the decision, ASIC Commissioner John Price said,

“The matter … highlights the need for people in business to recognise they are custodians of other people’s money. The High Court result provides clear guidance regarding important issues of principle that needed to be clarified for the benefit of responsible entities, their officers and investors. It is a positive outcome for investors, who need to be able to trust their representatives to act in their interests” (emphasis added).³

The case is a timely reminder of the high standard expected of directors in making decisions when the stakes are high, the amounts involved are significant and there are potential conflicts of interest involved. Directors are expected to apply an objective and inquiring mind, and devote appropriate and quality time, to the consideration of such matters and where appropriate, seek clear legal advice, judicial decision or members’ approval.

The court at first instance also made some helpful observations in relation to when a director can or should rely on professional advice in making a determination, which we summarise in the last section of this paper.

The Facts

ASIC v Lewski concerned decisions made by the directors of Australian Property Custodian Holdings Limited (Receivers and Managers Appointed) (In Liquidation) (Controllers Appointed) (APCHL), as the responsible entity of the Prime Retirement and Aged Care Property Trust (Prime Trust or Trust) between 2006 and 2008.

ASIC alleged that the directors of APCHL had contravened their duties to:

• exercise reasonable care and diligence;
• act in the best interests of the members of the Trust and give priority to the interests of the members over their own; and
• not to make improper use of their positions as officers of APCHL (amongst other duties),

when they decided to amend the Constitution of the Trust to permit the payment of a new Listing Fee, a new Removal Fee and an increased Takeover Fee to APCHL (Amendments or Fee Amendments).

At first instance, the primary judge found that the Amendments to the Constitution could not be made as a matter of law, as:

• the Amendments were made in favour of or resulted in benefits to APCHL, as responsible entity of the Trust, in breach of clause 25.1 of the Constitution; and
• the Board could not have reasonable considered, in accordance with section 601GC(1)(b) of the Corporations Act 2001 (Cth), that the Amendments would not adversely affected the members’ rights.⁴

Although this was overturned by the Full Court of the Federal Court which found that the Amendments had “interim validity” until set aside, the decision of the primary judge has now been reinstated by the High Court in a landslide win for ASIC.

Should the Board have made the Amendments?

The primary judge identified “Five Principal Factors” which, in approving the Fee Amendments, the Board should have been cognizant of:

1. the fees proposed to be paid were payable from the assets of the Trust to APCHL in its personal capacity;
2. the Amendments created self-evident conflicts;
3. the Amendments gave APCHL a contingent right to multiple fees;
4. the fees were substantial; and
5. the fees were gratuitous.

Confirming the primary judge’s findings, the High Court concluded that:

1. none of the directors could reasonably have believed that it was in the best interests of the members to bring the Fee Amendments into effect and accelerating the payment of the Listing Fee. In this regard, the joint judges commented:
   
   “The amounts of the “fees” were substantial. For instance, the Listing Fee of about $33 million amounted to between one-third and two-thirds of the entire capital expected to be raised on the listing. As for the Takeover Fee, in one scenario it could have required that a “fee” of $15 million be paid to APCHL following a takeover, increased from only $75,000 prior to the Amendments.”⁵; and
   
2. the directors at the Board meeting on 22 August 2006 ought reasonably to have known that their consideration of the Fee Amendments at the Board meeting on 19 July 2006⁶ was inadequate. Indeed, the primary judge found that:
   • the significant matters that the Board had to consider at its meeting in relation to the Fee Amendments could not have been considered within the 10 to 15 minutes that the Chairman of the Board said that it took; and
   • the absence of a record in the minutes to a discussion of the significant matters the primary judge had identified, shows that they were not discussed or were scantly discussed;
     
3. the directors should have voted against the resolution to give effect to the proposed amendments to the Trust’s Constitution (Resolution), in order to prioritise the members’ interests in having APCHL comply with the Constitution over the conflicting interest of APCHL in receiving the fees; and
   
4. given that the Resolution gave an advantage to APCHL and an indirect advantage to persons who would benefit from the fee paid to APCHL and caused detriment to the Trust, no reasonable person in each of the directors’ position could have considered it proper to pass the Resolution.

Could or should the Board have relied on the advice of its legal counsel?

The court at first instance was particularly critical of the legal advice that the Board had obtained regarding whether it could amend the Constitution without member’s approval. The primary judge observed that:

1. the legal advice:
   • was equivocal advice on whether the Board had power to make the amendment without member approval;
   • did not make a recommendation; and
   • left it to the Board to decide which conflicting interpretation was the correct one and the one they should follow.
     
     In the circumstances, the judge said that no reasonable director would have accepted the legal advice. Given the Five Principal Factors, the directors should have had the “alarm bells” ringing when the law firm advising them failed to make a recommendation on the correct interpretation of the Constitution;
     
2. directors can rely upon specialist advice but not at the expense of their non-delegable duties to take reasonable care;
   
3. whether reliance on advice is justified will depend on the circumstances. A director’s reliance on advice or information provided by others will be unreasonable where the director knows, or by the exercise of ordinary care should have known, any fact that would deny reliance on others. The following matters will also be important in determining whether a director’s reliance on another is reasonable:
   • the risk involved in the transaction and the nature of the transaction;
   • the extent to which the director is put on inquiry or, given the facts of a case should have been put on inquiry; and
   • whether the position of the director is executive or non-executive.

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1. APRA’s Prudential Inquiry into the Commonwealth Bank of Australia, April 2018.
2. ASIC v Lewski [2018] HCA 63 (a joint judgment of Kiefel CJ, Bell, Gageler, Keane and Edelman JJ), delivered 13 December 2018.
3. https://asic.gov.au/about-asic/news-centre/find-a-media-release/2018-releases/18-377mr-high-court-decision-on-prime-trust-directors/.
4. There was much discussion in the primary judge’s judgment about the equivocal nature of the legal advice received by the Board in amending the Constitution, which will not be reviewed in this note.
5. ASIC v Lewski [2018] HCA 63, [26].
6. The Board meeting on 19 July 2006 approved the Amendments but ASIC could not attack the actions of directors at that Board meeting, as that meeting was outside the statutory limitations period. ASIC thus relied on breaches of the Corporations Act resulting from the conduct of APCHL and its directors at the Board meeting on 22 August 2006 and later me

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