The Centro matter: ASIC v Healey [2011] FCA 717 and breach of director's duties.

The matter of Australian Securities and Investments Commission v Healey [2011] FCA 717 was a hearing in relation to the Centro group in the Federal Court of Australia before Middleton J. It concerned the scope of a director's duty to exercise reasonable care and skill in the context of understanding the financial reports of a company.

The judgment of Middleton J is an excellent read because it commences with a summary of His Honour's findings in relation to the scope of the director's duty to exercise reasonable care and skill. I have included a case summary and extracts of the judgment below.

The directors of the Centro group of companies, including Centro Properties Group (CNP) and Centro Retail Group (CER), were presented with the 2007 financial reports for each group. The financial reports were deficient in the following ways:

• The CNP report did not disclose around $1.5 billion of short term liabilities by classifying them as non-current liabilities.
• The CNP report did not disclose around $1.75 billion of guarantees of short term liabilities of an associated company.
• The CER report did not disclose around $500 million of short term liabilities by classifying them as non-current liabilities.

The directors signed off on these reports despite the errors. ASIC brought proceedings against the directors for breach of their director's duties, in particular under s180(1), 601FD(3) and 344(1) of the Corporations Act 2001 (Cth) (the Corporations Act).

The breaches of duty concerned with are in the terms of s180(1), as follows:

A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

(a) were a director or officer of a corporation in the corporation’s circumstances; and

(b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

The responsibility of a director when faced with a financial statement is summed up by Middleton J at [24]:

What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries.

The end result is that Middleton J found that the directors breached their duty to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would in a like position.

The following is an extract of the introduction by Middleton J from [8] to [23], which summarises the case and the principles to be applied:

8. By way of briefest summary, I make the following comments regarding the directors. The directors are intelligent, experienced and conscientious people. There has been no suggestion that each director did not honestly carry out his responsibilities as a director. However, I have found, in the specific circumstances the subject of this proceeding, that the directors failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them.
9. The 2007 annual reports of Centro Properties Group (‘CNP’) and Centro Retail Group (‘CER’) failed to disclose significant matters. In the case of CNP, the report failed to disclose some $1.5 billion of short-term liabilities by classifying them as non-current liabilities, and failed to disclose guarantees of short-term liabilities of an associated company of about US$1.75 billion that had been given after the balance date. In the case of CER, the 2007 annual reports failed to disclose some $500 million of short-term liabilities that had been classified as non-current.
10. This proceeding is not about a mere technical oversight. The information not disclosed was a matter of significance to the assessment of the risks facing CNP and CER. Giving that information to shareholders and, for a listed company, the market, is one of the fundamental purposes of the requirements of the Act that financial statements and reports must be prepared and published. The importance of the financial statements is one of the fundamental reasons why the directors are required to approve them and resolve that they give a true and fair view.
11. The significant matters not disclosed were well known to the directors, or if not well known to them, were matters that should have been well known to them.
12. In the light of the significance of the matters that they knew, they could not have, nor should they have, certified the truth and fairness of the financial statements, and published the annual reports in the absence of the disclosure of those significant matters. If they had understood and applied their minds to the financial statements and recognised the importance of their task, each director would have questioned each of the matters not disclosed. Each director, in reviewing financial statements, needed to enquire further into the matters revealed by those statements.
13. The central question in the proceeding has been whether directors of substantial publicly listed entities are required to apply their own minds to, and carry out a careful review of, the proposed financial statements and the proposed directors’ report, to determine that the information they contain is consistent with the director’s knowledge of the company’s affairs, and that they do not omit material matters known to them or material matters that should be known to them.
14. A director is an essential component of corporate governance. Each director is placed at the apex of the structure of direction and management of a company. The higher the office that is held by a person, the greater the responsibility that falls upon him or her. The role of a director is significant as their actions may have a profound effect on the community, and not just shareholders, employees and creditors.
15. This proceeding involves taking responsibility for documents effectively signed-off by, approved, or adopted by the directors. What is required is that such documents, before they are adopted by the directors, be read, understood and focussed upon by each director with the knowledge each director has or should have by virtue of his or her position as a director. I do not consider this requirement overburdens a director, or as argued before me, would cause the boardrooms of Australia to empty overnight. Directors are generally well remunerated and hold positions of prestige, and the office of director will continue to attract competent, diligence and intelligent people.
16. The case law indicates that there is a core, irreducible requirement of directors to be involved in the management of the company and to take all reasonable steps to be in a position to guide and monitor. There is a responsibility to read, understand and focus upon the contents of those reports which the law imposes a responsibility upon each director to approve or adopt.
17. All directors must carefully read and understand financial statements before they form the opinions which are to be expressed in the declaration required by s 295(4). Such a reading and understanding would require the director to consider whether the financial statements were consistent with his or her own knowledge of the company’s financial position. This accumulated knowledge arises from a number of responsibilities a director has in carrying out the role and function of a director. These include the following: a director should acquire at least a rudimentary understanding of the business of the corporation and become familiar with the fundamentals of the business in which the corporation is engaged; a director should keep informed about the activities of the corporation; whilst not required to have a detailed awareness of day-to-day activities, a director should monitor the corporate affairs and policies; a director should maintain familiarity with the financial status of the corporation by a regular review and understanding of financial statements; a director, whilst not an auditor, should still have a questioning mind.
18. A board should be established which enjoys the varied wisdom, experience and expertise of persons drawn from different commercial backgrounds. Even so, a director, whatever his or her background, has a duty greater than that of simply representing a particular field of experience or expertise. A director is not relieved of the duty to pay attention to the company’s affairs which might reasonably be expected to attract inquiry, even outside the area of the director’s expertise.
19. The words of Pollock J in the case of Francis v United Jersey Bank (1981) 432 A 2d 814, quoted with approval by Clarke and Sheller JJA in Daniels v Anderson (1995) 37 NSWLR 438, make it clear that more than a mere ‘going through the paces’ is required for directors. As Pollock J noted, a director is not an ornament, but an essential component of corporate governance.
20. Nothing I decide in this case should indicate that directors are required to have infinite knowledge or ability. Directors are entitled to delegate to others the preparation of books and accounts and the carrying on of the day-to-day affairs of the company. What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries.
21. No less is required by the objective duty of skill, competence and diligence in the understanding of the financial statements that are to be disclosed to the public as adopted and approved by the directors.
22. No one suggests that a director should not personally read and consider the financial statements before that director approves or adopts such financial statements. A reading of the financial statements by the directors is not merely undertaken for the purposes of correcting typographical or grammatical errors or even immaterial errors of arithmetic. The reading of financial statements by a director is for a higher and more important purpose: to ensure, as far as possible and reasonable, that the information included therein is accurate. The scrutiny by the directors of the financial statements involves understanding their content. The director should then bring the information known or available to him or her in the normal discharge of the director’s responsibilities to the task of focussing upon the financial statements. These are the minimal steps a person in the position of any director would and should take before participating in the approval or adoption of the financial statements and their own directors’ reports.
23. The omissions in the financial statements the subject of this proceeding were matters that could have been seen as apparent without difficulty upon a focussing by each director, and upon a careful and diligent consideration of the financial statements. As I have said, the directors were intelligent and experienced men in the corporate world. Despite the efforts of the legal representatives for the directors in contending otherwise, the basic concepts and financial literacy required by the directors to be in a position to properly question the apparent errors in the financial statements were not complicated.

The judgment is a strong reminder to directors that they need to be actively involved in the financial management of their company. A director needs to ensure he or she reads and understands the financial statements, and makes appropriate inquiries about the information within those statements. It is no excuse for a director to say that he or she relied on their accountant and automatically signed off on the financial statements assuming it to be correct.