Australian Securities and Investments Commission v. MacDonald (No. 11): corporate governance lessons from James Hardie.

• Jurisdiction: Australia
• Date: 01 December 2009
• Author: Hargovan, Anil

[Australian Securities and Investments Commission v Macdonald [No 11] required the New South Wales Supreme Court to determine whether company directors and officers of James Hardie Industries Lid had breached their duties, in particular the statutory duly of care and diligence in s 180(1) of the Corporations Act 2001 (Cth) in the context of the board approving and releasing to the Australian Securities Exchange a defective media statement that commented on the effects of a corporate restructure and the company's ability to meet future asbestos liabilities. Significantly, in affirming liability in respect of some of the civil penally charges laid by the Australian Securities and Investments Commission, Gzell J held that 10 former directors and officers of James Hardie Industries Ltd breached their duties of care by approving and releasing a media statement that was false, or misleading and deceptive, and capable of having an adverse effect on the company and the market. In holding that the company also breached its statutory obligations under the continuous disclosure provisions, Macdonald highlights the responsibilities of the board, chief executive officer und general counsel of listed companies to ensure compliance with the law. This case note analyses the reasons underpinning the outcome in Macdonald, with a focus on the modern scope and content of officers' and directors' duties. It considers the extent to which reliance can be placed by a non-executive director on other directors, management and external advisers and discusses the potential implications of the ease and the lessons that need to be implemented for sound boardroom governance.

CONTENTS I Introduction II Context: Special Commission of Inquiry A James Hardie's Activities B Impetus for Corporate Restructure C Key Features of the Separation Plan D Public Announcement of the Separation E Scheme of Arrangement and Relocation to the Netherlands F The Jackson Report and Its Significance III Australian Securities and Investments Commission v Macdonald [No 11] A Legal Issues B The Supreme Court Decision C Non-Executive Directors' Breach of Duty of Care and Diligence D Non-Executive Directors" Reliance Defence E Executive Directors' Breach of Duty of Care and Diligence F Officers' Breach of Duty of Care and Diligence G Directors' Duty to Act in Good Faith in the Best Interests of the Corporation and for a Proper Purpose H Penalties IV Implications A Non-Executive Directors B Statutory Defences C Company Secretaries D General Counsel E Continuous Disclosure F Lessons V Conclusion I INTRODUCTION

Corporate governance embraces, inter alia, 'how risk is monitored and assessed' and provides 'accountability and control systems commensurate with the risks involved.' (1) Corporate governance measures, in particular directors' duties, are but one of the many control devices relied upon to reduce the agency costs associated with shareholder monitoring. (2) The Berle--Means paradigm--which views the separation of ownership and control as being ownership dispersed among shareholders and control vested in directors (3)--has been highly influential in the development of corporate law norms in Anglo-American jurisdictions. To bridge the gap between shareholder and manager interests, a consequence of an 'agency problem' arising from divergent interests, (4) the board of directors has a duty to monitor management performance and to align managers' incentives with the shareholders' profit-maximising goal.

As a general rule, a company is to be managed by or under the direction of its board of directors. (5) The board's monitoring functions 'are the heart of what the agency cost model of the firm identifies as the central role for the board'. (6) The movement to take boards seriously, according to a leading commentator, has identified monitoring management decisions as a primary governance role of the board of directors. (7)

For the purpose of accountability and to minimise the risk of self-dealing and shirking by management, the law imposes both fiduciary duties and the duty to exercise care, skill and diligence upon officers and directors. (8) As fiduciaries, directors have an obligation to favour corporate interests over personal interests. (9) As monitors of management performance, boards of directors are accountable for decisions and conduct in office through the duty to exercise care, skill and diligence. Directors are expected to discharge their duties in a careful and competent manner. There is no place for underperformance or shirking of directors' duties, particularly when the board is entrusted with a specific task, as illustrated by the decision in Australian Securities and Investments Commission v Macdonald [No 11] ('Macdonald'), where eight former directors (seven non-executive and one executive) and two officers of James Hardie Industries Ltd ('JHIL') were found culpable of dereliction of duty.

The facts and decision in Macdonald underscore the failure of the JHIL board to discharge its dual role as adviser and supervisor. (10) The aim of this case note is to examine the decision and reasoning of the Supreme Court of New South Wales in Macdonald and to discuss the potential impact of the case on Australian corporate governance practices. However, first it is appropriate to discuss the antecedent and complex events leading to the relevant legal issues raised in Macdonald, which attracted great, and legitimate, public interest following the company's manifest intention at the outset to create a limited fund to compensate asbestos claims and thereafter to divest itself of future liabilities upon depletion of the fund.

II CONTEXT: SPECIAL COMMISSION OF INQUIRY

Macdonald came before the Supreme Court in the wake of the findings of a Special Commission of Inquiry established by the NSW government to examine, inter alia, the circumstances in which the Medical Research and Compensation Foundation Ltd ('Foundation') was created and separated from the James Hardie group and whether this may have impacted on the sufficiency of assets to meet its future asbestos-related liabilities. (11)

Before identifying the principal conclusions of the Special Commission of Inquiry, it is necessary to canvass the background to the events leading to the contentious corporate reconstruction of James Hardie and the facts leading to the commencement of civil proceedings in Macdonald by the corporate regulator for, inter alia, breach of directors' and officers' duties.

A James Hardie's Activities

Companies in the James Hardie group were major participants in the manufacture of asbestos products in the 1920s, which were used extensively in Australia during the major part of the last century, particularly in building products and insulation materials. James Hardie had been responsible for 70 per cent of Australian asbestos consumption. (12) Asbestos is injurious to health and its fibres can give rise to asbestosis, lung cancer and mesothelioma, which are often fatal. These diseases may not manifest themselves immediately, and it is not uncommon for a severe medical condition to arise some decades after exposure to the asbestos fibre. Asbestosis was common in the 1920s, but the insidious effect of asbestos and its link to mesothelioma were only established in 1960. (13)

JHIL (now 'ABN 60 Pry Ltd') manufactured asbestos products until 1937, whereupon this activity was taken over by its subsidiary, James Hardie & Coy Pty Ltd (now 'Amaca Pry Ltd'), which became a substantial producer until it ceased this business activity in the 1980s. (14) Another business arm of the corporate group, Jsekarb Pty Ltd (now 'Amaba Pty Ltd'), manufactured brake lining products until its sale to an independent party in 1987. (15) These three companies in the James Hardie group were the main participants in the manufacture and distribution of asbestos products. These companies, together with Mr Macdonald as JHIL's chief executive officer, Mr Shafron as the company secretary and general counsel, and Mr Morley as the chief financial officer, were to form the dramatis personae in the corporate reconstruction of James Hardie. (16)

B Impetus for Corporate Restructure

A switch in business focus to the United States and the development of new non-asbestos products in the 1980s proved successful for the James Hardie group and provided the impetus to separate the accruing asbestos liabilities in Australia from the group's core business in the United States. (17) This impetus to divest itself of its asbestos liabilities also came from the desire of the group to remove what it perceived as an obstacle to its aspirations to access the capital market in the United States. An aborted attempt to issue 15 per cent of the shares of a related Dutch company, James Hardie Industries NV ('JHINV'), on the New York Stock Exchange added to the impetus for a corporate restructure to 'fully realise the value of JHIL, and for its growth prospects to be realised', by adopting the United States as the group's base. (18) Without separation of the asbestos-related liabilities on its balance sheet, it was thought that 'listing in the United States was "commercially unrealistic"'. (19)

Three other influential factors contributed to the momentum towards the group's corporate reconstruction and its timing. The first factor was the desire to avoid the impact of a proposed new Australian Accounting Standard, (20) due to come into force in October 2001, which would have required disclosure of the group's estimated total of its asbestos liabilities. (21) The second factor was the desire to capitalise on the timing of the announcement of the group's third quarter results to the market on 16 February 2001. (22) It was envisaged that the simultaneous announcement of the group's profits together with the corporate restructure plan would deflect attention from a controversial issue which might otherwise attract undesirable publicity. The third...