The James Hardie case: risk, reputation and business ethics
This article was published in Living Ethics: issue 88 winter 2012
Much has been written about the James Hardie appeal decision since it was handed down by the High Court in May this year—although it is generally agreed by commentators that no new legal precedents have been set. Far from being a landmark decision, it has probably not taken the law relating to directors duties any further. In fact, it probably does little more than reinforce what the Federal Court enunciated about directors’ duties in the Centro case in 2011.
The James Hardie case from the outset was one which largely turned on its particular facts, following an initial finding in the NSW Supreme Court, that the 7 non-executive directors and 3 senior executives (the former CEO, CFO and general counsel) of James Hardie had breached their statutory obligations under section 180(1) of the Corporations Act 2001 (the Act), to act with care and diligence in performing their duties. The seven judges of the High Court unanimously upheld the decision of the NSW Supreme Court.
But behind the legal wrangling, there are intriguing lessons to be learned by those involved in managing companies, as the James Hardie case carries with it a tale of risk, reputation and business ethics.
The proceedings arose out of the 2001 restructure of the James Hardie Industries Limited (James Hardie) group of companies. Two subsidiaries with significant asbestos-related liabilities were ‘separated’ from the group and the Medical Research and Compensation Foundation (the Foundation) was established to fund compensation claims made against the separated companies by people injured by their asbestos products. On 15 February 2001, the board of James Hardie approved the separation proposal. The next day, James Hardie sent the Australian Stock Exchange (ASX) an announcement outlining the proposal. The announcement contained misleading statements about the sufficiency of the funds available to the Foundation to meet present and future claims.
In February 2007, the Australian Securities and Investments Commission (ASIC) brought civil penalty proceedings in the Supreme Court of New South Wales against the defendants (and others) for contravening s.180(1) of the Act. ASIC alleged that the board of James Hardie, at its meeting on 15 February 2001, had approved a draft ASX announcement not materially different from the announcement that was made. ASIC alleged that the defendants, other than Mr Shafron, (the former company secretary and general counsel to James Hardie), had breached their duties as directors by approving the draft announcement, and that Mr Shafron, had breached his duty as an officer in several ways, including by not advising the board that the draft announcement was misleading.
Mr Shafron had argued that the contraventions of s.180(1) of the Act (breach of duties of care and diligence by an ‘officer’ of a corporation) alleged against him related to his responsibilities as general counsel and not to his responsibilities as an ‘officer’ of the company and should therefore not be subject to s.180(1). Mr Shafron did not dispute that s.180(1) applied to him in his capacity as company secretary, but he maintained that the alleged contraventions of the section related to his actions solely in his capacity as general counsel. Accordingly, the section should have no application to him in that capacity. However, the High Court affirmed the lower court findings. These were that Mr Shafron had failed to advise either the CEO or the board of James Hardie that the company should disclose to the stock exchange certain information contained in a Deed of Covenant and Indemnity. Additionally, he had failed to advise the board that the actuarial study he had commissioned to predict asbestos-related liabilities, suffered from critical limitations (that ultimately resulted in the Foundation being underfunded by some $1.3 billion).
At trial, ASIC tendered the minutes of the February board meeting that recorded the tabling and approval of a draft ASX announcement advising the stock exchange about the establishment of the Foundation. The announcement advised the market that the Foundation was ‘fully funded’ in terms of its ability to meet present and future claims by former employees suffering from asbestos- related injuries. Those minutes had been adopted and signed as a correct record at the next board meeting in April 2001. Two witnesses called by ASIC to give evidence about the board meeting were unable reliably to recall events. The defendants claimed that the minute recording tabling and approval of the draft announcement was false and that the minutes were demonstrably wrong in other respects. Those of the defendants who gave evidence at the trial did not accept that they had approved a draft ASX announcement.
However, the High Court had no difficulty in finding that the seven non-executive directors of James Hardie had each breached their duties as a director of the company by approving the company’s release of a misleading announcement to the ASX about the adequacy of funding for the Foundation. The High Court also found that Peter Shafron, had breached his duties as an officer of the corporation by failing to discharge his duties with the degree of care and diligence that a reasonable person in his position would have exercised.
The penalties originally handed down by Gazell J. at first instance in the NSW Supreme Court are certainly sobering. All ten defendants in the civil proceedings brought by ASIC were banned from being a company director or otherwise being involved in the management of a company for periods ranging from 5 years to 15 years. The monetary penalties ranged from $30,000 to $350,000. While the highest penalty was handed out to the former CEO, Peter McDonald, the second highest penalty of a 7 year disqualification and a $75,000 penalty was afforded the former general counsel and company secretary, Peter Shafron.
Risk, reputation and business ethics
The reputations and career prospects of the former directors and officers of James Hardie are in ruins. The reputational damage to the James Hardie brand is immense. And stemming from that is the damage to the company’s ASX listing and market value (which has a flow on effect to the innocent shareholders). Not to mention the tsunami of adverse media coverage.
Was the risk taken by the officers of James Hardie in not providing full and frank disclosure, firstly to the board and secondly to the stock exchange, worth the incalculable damage done to the company’s image and their own reputations? The answer should be clear to even the most casual observer.
While the ethical behaviour of the officers of James Hardie was perceived through the media as one of an avaricious corporation seeking to deprive long-suffering persons with life-threatening asbestos-related injuries from fair and just compensation, there was another ethical issue in the case. This time it was in relation to the party on the other side of the proceedings, ASIC, and how it went about the conduct of its case.
ASIC, as a federal regulator, has an obligation to conduct proceedings as a ‘model litigant’ under guidelines set down by the Commonwealth Government. The model litigant rules require a Commonwealth litigant, such as was ASIC in this case, to act fairly in the conduct of legal proceedings. One question that arose for decision before the High Court was whether ASIC had ‘played fair’ in not calling as a witness a person who the defendants believed could give critical evidence in the case. ASIC did not call James Hardie’s external solicitor (Mr David Robb of law firm Allen, Allen and Hemsley) who had supervised the preparation of the draft board minutes and had attended the February board meeting. It was felt that Mr Robb could give important evidence about the accuracy of the minutes from the relevant board meeting and also assist in establishing whether in fact a draft ASX announcement had been before the board and approved by it. Before the High Court, ASIC argued that while it has an obligation to act as a ‘model litigant’, that obligation does not encompass a duty to call all material witnesses.
The High Court accepted, as had the NSW Court of Appeal, that ASIC was under a duty or obligation of ‘fairness’, but rejected the Court of Appeal’s conclusion that failure to call a material witness in civil proceedings amounted to a breach of that duty that had the effect of undermining or diminishing the cogency of ASIC’s case. The High Court made it clear that a regulator conducting civil penalty proceedings is under no obligation akin to a prosecutor’s duty to call all material witnesses at a criminal trial. Accordingly, the High Court found that ASIC’s decision not to call Mr Robb caused no unfairness and that there was no basis for drawing any inference that Mr Robb would have given evidence adverse to ASIC’s case.
Where to from here?
While upholding the findings of the trial judge in relation to the liability of the officers of the company, the High Court has remitted back to the NSW Court of Appeal for consideration, claims by the defendants to be excused from liability, penalty and disqualification. Under the Corporations Act a court may relieve a person from a liability where it appears to the court that the person has acted honestly and, having regard to all the circumstances of the case, the person ought fairly be excused for the contravention. So the James Hardie case has yet to be fully played out.