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Across the Board: Non-executive Directors, Part 2

Aug 2019

The same legislative duties apply to both executive and non-executive directors. It is clear, however, that the commercial reality of the non-executive role means that the type of duty imposed on a non-executive director must be somewhat different to the duties imposed on an executive director.

In this Part 2 of our “Across the Board” series focusing on non-executive Directors, we consider the impact of ASIC v Rich on directors’ duties as they apply to non-executive directors.

In the final report of the Banking and Financial Services Royal Commission1, Commissioner Hayne noted three chief benefits of including non-executive directors on ASIC’s board, being:

  • enhancing the internal oversight function of the board of directors;
  • broadening the skills and experience of the board; and
  • reinforcing ASIC’s independence from the government and those it seeks to regulate.

Commissioner Hayne further stated that these benefits were directly comparable to the benefits yielded from the presence of non-executive directors on the board of profit-making corporations.

In this series, we are delving further into the concept of non-executive directors. In Part 1 of this series, we examined the differences between non-executive and executive directors under the Corporations Act 2001 (Cth) (the Act) and in commercial practice. In this second article, we will assess whether those differences have any impact on directors’ duties, particularly in light of the leading NSW Supreme Court decision in ASIC v Rich. In Part 3 of this series (to be published in September), we will use Commissioner Hayne’s comments as a guide to determine how a private company can get the most value out of the non-executive director role.

Directors’ Duties

As highlighted in Part 1, the distinction between executive and non-executive directors does not exist under the Act – rather, the distinction is purely commercial. While this means that the duties imposed on directors by legislation apply to all directors irrespective of their day-to-day involvement in a company, courts have recognised that the scope and application of these duties can vary from director to director.

The nature of an individual director’s duties will therefore be shaped by their role and responsibilities in the company.

Directors’ duty of care and diligence

While no distinction is formally drawn between executive and non-executive directors, section 180(1) of the Act states that the directors’ duty of care and diligence must be applied to the degree that a reasonable person would exercise if they were in the place of the individual director, in the circumstances of the corporation, occupied the same office and had the same responsibilities.

The leading case on section 180 remains ASIC v Rich, which dealt with ASIC’s prosecution of the former directors of One.Tel. While the case itself turned on questions of fact (and ASIC was ultimately unable to prove its case), Austin J took the opportunity to consider the construction and meaning of section 180 in some detail.

Considering the standard set in section 180(1), Austin J recognised explicitly that the provision was drafted to “make it clear… that non-executives directors are not subject to the same (higher) standard as executive directors, and… to affirm that the statutory standard, while related to the office held and the responsibilities of that office, was intended to be an objective standard.”

The standard of care and diligence required must then be altered for executive and non-executive directors, so far as may be considered reasonable in the circumstances. Austin J stated that factors to be considered when assessing the circumstances of the corporation could include:

  • the type of company involved;
  • the size and nature of its business;
  • the provisions of its constitution;
  • the composition of the board; and
  • the distribution of work between the board and other officers.

In considering responsibilities, Austin J stated that the specific responsibilities of an individual director should be considered in light of the factual arrangements operating within the company, including any special arrangements flowing from the experience and skills that a person brings to bear on the office, and any specific working arrangements with the board and the executive. Importantly the duty is not confined only to those specific tasks assigned to the director in writing but must be viewed as a matter of factual responsibility. This is broadened by the minimum standards set out by Austin J for diligence – including familiarity with the business, its activities, its financial status and its financial capacity – and skill, which encompasses competence and awareness.

Where the duty of skill as an objective standard is determined by reference to what a reasonable person of ordinary prudence would do, the court recognised that the standard would ‘have somewhat different consequences for executive and non-executive directors’. Particularly, it found that ‘the objective duty of minimum skill and competence may not extend much beyond financial matters’ for non-executive directors, but would ‘reflect what is objectively expected of a person appointed to a non-executive director role.

The principles set out in ASIC v Rich in relation to s 180(1) have since been affirmed in the more recent cases of ASIC v Cassimatis (No 8) (Edelman J) and Termite Resources v Meadows (White J).

Implications of ASIC v Rich for the director

It is vital then that all directors are, at a minimum, actively informed about the company on whose board they serve, and possess a good standard of financial literacy and understanding about that company’s operations and affairs. For larger boards, subdivisions of responsibility may require that non-executive directors be held to a higher standard for their personal portfolio. For non-executive directors who are brought onto a board because of specialist skills and expertise, such directors will be held to a standard of skill which befits their experience and role. For non-specialist non-executive directors, and for specialist non-executive directors responsible for an area outside their area of expertise, there is a significant grey area to be explored. Clearly non-executives are not expected to maintain currency and familiarity with the business to the degree that executive directors must, but the standard will clearly require more than a cursory awareness of such matters.

Directors’ duties and the Business Judgment Rule

Some reassurance can be found in section 180(2) which provides a “safe harbour” for directors who make “business judgements” (i.e. decisions – even poor decisions) which are rational, independent, informed, and in good faith. Independence, information and good faith are all familiar concepts for directors. Rationality also appears to be a relatively low bar – a decision will only be irrational where no reasonable person in the same position would make the same judgement.

While there is some academic debate on the practical effect of the section (since both 180(1) and (2) apply a standard of reasonableness), a prudent approach would be for all directors – and particularly non-executive directors ¬– to adopt as a decision-making checklist the requirement that all decisions be made rationally, without personal interest, with critical consideration of the relevant information, and with the best interests of the company and its members at the front of its mind.

In Part 3 of the Across the Board series, we will consider the practical implications of the above, and further explore how companies can get the most out of their non-executive directors in light of the comments of the Banking Royal Commission.

Material in this article is available for information purposes only and is a high level summary of the subject matter. It is not, and is not intended to be, legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this article. This article is copyright. For permission to reproduce this article please email Hazelbrook Legal: enquiry@hazelbrooklegal.com

References

  1. Banking Royal Commission, Final Report
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