Federal Court establishes the benchmark for directors
In a recent decision of the Federal Court the directors of Centro Properties Limited (and related companies) were found to have breached the Corporations Act 2001 (Cth) in a number of key areas. This decision has significant and important implications for company directors.
In a recent decision of the Federal Court of Australia in ASIC v Healey [2011] FCA 717 it was determined that the directors of Centro Properties Limited had breached their obligations under the Corporations Act 2001 (Cth) (Corporations Act) in failing to notice significant errors contained in the 2007 consolidated financial statements of Centro Properties Limited, Centro Property Trust and Centro Retail Trust (CRT) (collectively Centro).
The Facts
In late 2007, Centro admitted that certain debt figures released in its 2007 Annual Reports were materially inaccurate. Specifically, Centro had incorrectly classified approximately $1.5 billion of current liabilities as non-current liabilities and had failed to disclose guarantees of short-term liabilities to an associated company of approximately US$1.75 billion. Further, CRT failed to disclose approximately $500 million of current liabilities; incorrectly classifying the debt as non-current. The Company’s Auditors, PricewaterhouseCoopers (PwC) also failed to detect the identified errors.
ASIC initiated court proceedings against the Centro directors and in doing so sought declarations that the directors had contravened the Corporations Act.
The Court found that while there was no suggestion that the relevant directors had acted intentionally or dishonestly in failing to recognise and remediate the errors in the financial statements, the directors were aware of information that should have made brought the identified errors to their attention.
Key Issues
Misclassification of current liabilities as non-current
Company directors are obliged under the Corporations Act to review the financial statements and notes to these statements to declare that these give a true and fair view, in all material respects, of the financial position and performance of the company and, if relevant, the consolidated entity.
The primary issue in these court proceedings was, therefore, the level to which a director is required to critically appraise proposed financial statements in order to determine whether they are not only consistent with the director’s own knowledge of the company’s financial position and performance but that they also do not omit material matters.
The Centro directors relied upon advice received from financial managers and PwC. While this reliance was not considered unreasonable, the Court found that such assurances from Centro management and the company auditors did not absolve the directors in having to bring an enquiring mind to a review of applicable financial statements.
Critically, the Court held that directors of companies must have sufficient financial literacy to understand financial statements together with the knowledge of accounting standards to be aware of requisite inclusions. The Corporations Act requires directors to form an opinion about the accuracy of financial reports and, therefore, it is not considered possible for a director to form such an opinion in the absence of such knowledge. In keeping with this requirement, the Court found that it is not permissible for a director to delegate this responsibility to management or company auditors.
ASIC further alleged that the conduct of the Centro directors contravened requirements of the Corporations Act requiring a director to exercise his or her powers and discharge his or her duties with the degree of care and diligence that a reasonable person would exercise if that person was a director of a corporation in similar circumstances. Whilst there was no suggestion that the directors had acted dishonestly in carrying out their responsibilities (and to the contrary were clearly intelligent, experienced and conscientious people), the Court determined that the directors had nonetheless contravened the relevant provisions of the Corporations Act in failing to take all reasonable steps to ensure compliance with the Corporations Act regarding the financial statements and, in addition, had failed to exercise the degree of care and diligence required when reviewing the financial statements.
Post balance date events
Accounting standards and the Corporations Act require that companies disclose material facts and events that arise after the reporting date which have or may have a significant impact upon the operations of the company or consolidated entity, the results of those operations or the state of affairs of the entity in subsequent years.
Accordingly, the Court found that Centro should have disclosed approximately US$1.75 billion in guarantees provided to a related business entity; these were due to mature within 12 months of the balance date and in light of the magnitude of the guarantees and their impact on the financial position of the entity dictated that these were events warranting disclosure as material events arising after the reporting date.
Section 295A Declaration
The Corporations Act provides that a director can only make a declaration that the financial reports comply with legal standards and requirements in representing a true and fair view of the financial position and performance of the entity following receipt of a declaration by the people performing the functions of CEO and CFO within the entity. In this case, the Court found that the disclosure letter issued to the Centro Board by the chief executive and chief financial officers did not (in form or substance) comply with the requirements of the Corporations Act. Further, a simple reading of the relevant provision would have made it clear to the directors that the requirements had not been satisfied. As a consequence, the directors were found to have failed to take all reasonable steps to secure compliance with the reporting provisions of the Corporations Act.
Implications for Directors
The Centro Case has highlighted that the task of reviewing company accounts demands critical and detailed attention and cannot be satisfied by merely ‘going through the motions’ or placing sole reliance on others regardless of the level of competence demonstrated by these advisers. Directors need to critically examine all financial statements and report and to evaluate these based on their own accumulated knowledge of an entities affairs and activities. In addition, directors must also be sufficiently familiar with fundamental and critical accounting standards in order to determine what should be included in financial statements and whether there are any material omissions or misstatements.
If directors are aware that compliance with certain provisions of any legislation or regulatory requirements is required it will be incumbent upon the director to inform him or herself of the relevant requirements; ignorance of these will not be a defence in an action for a failure to comply with the applicable requirement. Consideration should be given as to whether directors are being presented with the most useful and meaningful information. The provision of too much information may mean that directors are unable to focus on what is truly important thereby potentially overlooking vital information and possible warning signs. Conversely, the adoption of a minimalist approach to information provided to boards may mean that the directors are not in a position to fully understand and interpret in sufficient detail the material affairs and operations of the entity.
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