Case note: directors successfully rely on business judgment rule

In Australian Securities and Investments Commission v Mariner Corporation Limited [2015] FCA 589 Justice Beach of the Federal Court dismissed an application by ASIC for declarations that each of the directors of Mariner breached his duty to act with due care and diligence in contravention of section 180(1) of the Corporations Act by making a reckless decision that Mariner would announce a takeover bid for Austock without securing funding. He concluded that each of the directors satisfied the requisite elements of the business judgment rule in section 180(2) and was entitled to its exculpatory operation.

After considering the evidence Justice Beach concluded that Mariner was not “reckless”.

He rejected the proposition that a breach by a company automatically meant directors had breached their individual duties. He analysed the duties of directors, their obligations when taking risks and the requirements of the business judgment rule.

In considering whether the directors exercised reasonable care and diligence he noted that the duty depends on a number of factors:

  • the circumstances of the particular company concerned including the size and type of the company, the size and nature of the business it carries on, the terms of its Constitution, and the composition of the board of directors.
  • the director’s position and responsibilities, the director’s experience and skills, the terms and conditions on which he has undertaken to act as a director, how the responsibility for the company’s business has been distributed between the directors and the company’s employees, the informational flows and systems in place and the reporting systems and requirements within the company.
  • the relevant acts, omissions and circumstances in the given case.

The business judgment rule
Justice Beach discussed the conduct of each of the 3 directors. His analysis in respect of director Mr Olney-Fraser is worth noting:

The first requirement of the rule is that there must be a “business judgment”. To be a business judgment there must be a decision to take or not to take action in respect of matters relevant to the business operations of the corporation. In the present context, the relevant ‘business judgment’ was the decision to initiate a takeover bid for Austock, the necessary starting point for which was the making of the 25 June announcement. Having regard to the nature of Mariner’s business and the evidence concerning the potential benefits to Mariner of attaining control of Austock, the decision to commence the takeover and make the 25 June announcement was a business judgment. ASIC’s characterisation of the directors’ decision as a judgment not to comply with the Act and its reliance upon ASIC v Fortescue Metals Group Ltd … (set aside on other grounds), is a misconceived analysis of the judgment made by Mr Olney-Fraser. No decision was made not to comply with the Act, indeed the converse.

Further, Mr Olney-Fraser consciously exercised his judgment to support the takeover bid for Austock and the 25 June announcement. Mr Olney-Fraser also gave evidence that, given the circumstances, a “drover’s dog” could have funded the bid. This evidence is to be viewed in the light of his substantial and relevant experience in these types of deals.

The second requirement is that the judgment be made in good faith for a proper purpose. This requirement is satisfied. Mr Olney-Fraser decided to support the takeover and make the 25 June announcement because of the potential for Mariner to make a significant profit, and where he believed that the decision to make the announcement and pursue a takeover bid for Austock was in the best interests of Mariner.

As to the third requirement, that there be no material personal interest in the subject matter of the judgment, this was satisfied.

As to the fourth requirement, to “inform themselves of the subject matter of the judgment to the extent they reasonably believe to be appropriate”, in ASIC v Rich at [7283] and [7284], Austin J stated:

[7283] The element of the business judgment rule set out in s 180(2)(c) is that the director or officer must inform themselves about the subject matter of the judgment to the extent that they reasonably believe to be appropriate. I agree with ASIC’s submission …. that the reasonableness of the belief should be assessed by reference to:

• the importance of the business judgment to be made;
the time available for obtaining information;
the costs related to obtaining information;
the director or officer’s confidence in those exploring the matter;
the state of the company’s business at that time and the nature of competing demands on the board’s attention …; and
whether or not material information is reasonably available to the director ….

[7284] ASIC submitted … that the requirement that the director or officer inform themselves “to the extent they reasonably believe to be appropriate” reflects the view that regard must be had not only to what the director or officer actually knew, but what he or she should have known (citing People’s Department Store Inc v Wise [2004] 3 SCR 461 at [67]). In my view that submission distorts the statutory language, for it would deny protection unless the director were able to show previous compliance with the duty of care and diligence on another issue, namely to keep informed of material matters affecting the exercise of the powers and the discharge of the duties office. The statutory language relates to the decision-making occasion, rather than the general state of knowledge of the director. It requires the director to become informed about the subject matter of the decision prior to making it, since the business judgment rule should not protect decisions taken in disregard of material information readily available. The qualifying words, “to the extent they reasonably believe to be appropriate”, convey the idea that protection may be available even if the director was not aware of available information material to the decision, if he reasonably believed he had taken appropriate steps on the decision-making occasion to inform himself about the subject matter.

Mr Olney-Fraser considered that he had been provided with sufficient information to make an informed judgment to vote by having various meetings and discussions with Arena and others and his knowledge of the level of interest in Austock’s two businesses.

In these circumstances, Mr Olney-Fraser informed himself to the extent he believed appropriate and therefore met this fourth requirement.

As to the final requirement (that the director rationally believed that the judgment was in the best interests of the corporation), Mr Olney-Fraser held a belief that the takeover bid and 25 June announcement were in the best interests of Mariner. The content of this limb was explained by Austin J in ASIC v Rich in terms:

[7290] On this view, which I favour, subpara (d) is satisfied if the evidence shows that the defendant believed that his or her judgment was in the best interests of the corporation, and that belief was supported by a reasoning process sufficient to warrant describing it as a rational belief, as defined, whether or not the reasoning process is objectively a convincing one…

Mr Olney-Fraser held the requisite belief. It was not a belief that no reasonable person in Mr Olney-Fraser’s position would have held. Accordingly, the belief was a rational one. Alternatively, as a matter of substance and in any event, Mr OlneyFraser’s process of reasoning was rational.

In my opinion, Mr Olney-Fraser has satisfied the requisite elements of the business judgment rule and is entitled to its exculpatory operation if he otherwise needs to rely on it.

Risk taking by directors
Justice Beach discussed the liability of directors for risk taking as follows:

“… an important point of difference between ASIC and the defendants concerns the extent to which a director should be taken to have contravened s 180 by reason of being involved in a contravention by the company of another provision of the Act.

The duty owed under s 180 does not impose a wide-ranging obligation on directors to ensure that the affairs of a company are conducted in accordance with law. It is not to be used as a back-door means for visiting accessorial liability on directors.

It is wrong to assert that if a director causes a company to contravene a provision of the Act, then necessarily the director has contravened s 180.

No contravention of s 180 would flow from such circumstances unless there was actual damage caused to the company by reason of that other contravention or it was reasonably foreseeable that the relevant conduct might harm the interests of the company, its shareholders and its creditors (if the company was in a precarious financial position) ….

In order for an act or omission of the director to be capable of constituting a contravention of s 180 there must be reasonably foreseeable harm to the interests of the company caused thereby.

Further, relevant to the question of breach of duty is the balance between, on the one hand, the foreseeable risk of harm to the company flowing from the contravention and, on the other hand, the potential benefits that could reasonably be expected to have accrued to the company from that conduct.

Not only must the Court consider the nature and magnitude of the foreseeable risk of harm and degree of probability of its occurrence, along with the expense, difficulty and inconvenience of taking alleviating action, but the Court must balance the foreseeable risk of harm against the potential benefits that could reasonably be expected to accrue from the conduct in question.

After all, one expects management including the directors to take calculated risks. The very nature of commercial activity necessarily involves uncertainty and risk taking. The pursuit of an activity that might entail a foreseeable risk of harm does not of itself establish a contravention of s 180. Moreover, a failed activity pursued by the directors which causes loss to the company does not of itself establish a contravention of s 180.

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