High time to stop flogging diligent directors

It's unrealistic and almost certainly counter-productive to hold non-executive directors to the same standards as executives. AICD's latest push may finally bring that fact proper recognition.

The ‘Performance versus Conformance’ debate is about to open on a new front, with the Australian Institute of Company Directors launching a campaign to create a “safe harbour” for honest and diligent directors.

Actually, it isn’t really a new front but an old one re-visited as it is the latest in a succession of attempts over the years to provide a business judgment defence for directors. This time, with a federal government focused on reducing red tape and improving economic output, it might have a more realistic chance of succeeding.

There actually is a business judgement defence in the Corporations Act but it has such limited application and has been interpreted so narrowly by the courts that it doesn’t provide any real protection for directors.

It doesn’t protect them from personal liability for alleged breaches of disclosure laws, or company reporting laws, or insolvent trading – nor from being found in breach of their duties because their company has breached the Act.

It also doesn’t, as Centro directors discovered, protect them for not doing something.

Centro directors made the “mistake” of relying on their management and auditors to properly classify the group’s liabilities. They didn’t, the non-executives didn’t pick up the omission and the Australian Securities and Investment Commission took a successful action against the board, although the non-executives received only a slap on the wrist from the court.

Surveys undertaken by the AICD have consistently found that directors are conscious of their personal liabilities and that the risk of being found liable caused them to be overly-cautious in their decision-making, leading to them making less than optimal business decisions.

There’s a lot of anecdotal evidence that boards spend as much if not more time on compliance issues and ‘box ticking’ as they do on actual business decisions – which might explain why boards with a majority of independent directors under-perform those without. Independent directors have more to lose than to gain from endorsing risk-taking by their companies (Debunking the myths of board independence, 30 July).

The AICD would also argue that their liability may also cause directors to prematurely, and perhaps unnecessarily, put their companies into some form of administration, damaging the interests of creditors, shareholders and employees.

Recent court cases – and the Centro and perhaps James Hardie cases illustrate the point – have also blurred the demarcation between non-executive directors and executives and caused boards to focus even more on compliance issues because they can’t rely on the courts making a distinction between the responsibilities and liabilities of management and professional advisers and those of part-time non-executives.

A particular concern is what AICD describes as the “stepping stone” cases: cases which start with an action against the company for some alleged contravention of the Corporations Act and, once corporate fault has been established, leads to a finding that directors have breached their statutory duty of care by exposing their company to liability or reputational damage. It is conceivable that the directors could be disqualified and/or face harsh financial penalties that are more punitive than that faced by their company.

The AICD proposal is for the addition of an “over-arching” defence for directors who have acted honestly and reasonably.

The proposed addition to the Corporations Act reads:

"Notwithstanding any other provision of this Act or the ASIC Act, if a director acts (or does not act) and does so honestly, for a proper purpose and with a degree of care a diligence that the director rationally believes to be reasonable in all the circumstances, then the director will not be liable under, or in connection with, any provision (including any strict liability offence) of the Corporations Act or the ASIC Act (or any equivalent grounds of liability in common law or in equity) applying to the director in his or her capacity as a director.’’

The onus would be on the director to demonstrate, on the balance of probabilities, that they had acted honestly and reasonably.

It is unrealistic and almost certainly counter-productive to hold non-executive directors to account – whether via the law or public opinion -- using the same standards that might apply to executives. They aren’t executives; they aren’t, as a group, specialists in corporate law or accounting. They have to make decisions in real time on the basis of information that is necessarily imperfect – they aren’t prescient.

It is neither reasonable nor fair that someone acting honestly, diligently, reasonably and in the perceived best interests of their company should, with the benefit of hindsight, face liabilities.

It is understandable that the prospect of those liabilities and reputational damage might have a chilling impact on their ability to approve risk-taking by their companies and create an incentive for them to devote more time and attention to governance issues than to actual business decision-making.

Whether or not the specific AICD proposal is accepted and adopted, the context within which directors operate does need to be seriously debated and some measures to tilt the boardroom balance away from conformity towards performance, including a safe harbour for honest and diligent directors, seriously considered.

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