Comercial and corporate law for accountants ( australia)

Answer

Assignment 2 Case Study

Identification of Legal Issues

The case presents Rocky, Drago, and Clubber; the directors of DEF limited incorporated in the first month of 2011. The directors also hold other positions in the company with Rocky being the chief executive officer, Clubber, the chair of DEF Ltd, and Drago, the company’s chief executive officer. The three have raised $10 million from investors and have started engaging in exploration activities in July 2011. However, the results of a survey conducted revealed that their drilling of the mining sites is uncommercial due to the low levels of gold deposits. In a board meeting, a deliberation is held on whether to abandon the exploration activities and return the remaining capital to the shareholders. However, the directors agree that the company should continue with the drilling program. When they completed the drilling program; and upon exhausting the capital of the company, they fail to make any significant discoveries.

One of the legal issues which arise in this case is whether the directors (Rocky, Drago, and Clubber) breached the director’s duties; primarily the responsibility of good faith, the duty to act for a proper purpose, and the duty of care and diligence. If yes, the second issue is whether the three directors have an arguable defence for their actions. Finally, there is a legal issue as to whether the same standard applied to Rocky (the company’s chief executive officer) and Clubber (the chair of the organisation) will be used to Drago (the chief financial officer of the organisation).

Relevant Law

The relevant law, in this case, is the Australian Corporations Act 2001^[1] and precedents on the field. In specific, a director is defined as a person who has been validly appointed as a director or alternate director or one who acts in the position of a director (de facto director)^[1]. The Act provides four primary duties of directors. One of those is that of care and diligence. In specific, directors are required to act with a degree of care and diligence that a reasonable person holding a similar role might be expected to show. Additionally, directors should act in good faith and in the best interests of the company.^[1] Moreover, directors are not to act in a manner which might be considered an improper use of their position to gain an advantage to themselves or someone else or even to the detriment of the company^[1]. Furthermore, sec.183^[1] mandates directors not to improperly use the information from the company to gain an advantage for themselves or someone else or use the information to the detriment of the company.

Apart from the four main duties of the Act, there are other additional duties. Under sec.588G,^[1] directors have a duty of ensuring that the company does not engage in insolvent trading especially where they suspect that it might be insolvent. Additionally, sec.344^[1] requires the directors of a company to take reasonable steps towards ensuring that the company complies with the obligations of the law in terms of keeping financial records as well as financial reporting. Moreover, sec.191^[1] makes it mandatory for directors to disclose matters relating to the company affairs where they have a material personal interest. Also, for public companies sec.205G^[1] requires directors to disclose any material interest to the market. Further sec.188^[1] makes it mandatory for directors to lodge information with the Australian Securities and Investments Commission (ASIC). Finally, the Act requires directors to continually disclose to the market information which may affect its share price; especially if it is a listed company.

Analysis and Application

The case shows that after the three directors had a survey conducted to determine the viability of their mining, it was established that they the exploration project was not commercially viable as there were low levels of gold. Nevertheless, the directors went ahead with the exploration mission which resulted in the exhaustion of the assets of the company. The directors are expected to exercise a reasonable degree of care and diligence in the exercise of their duties. According to the Federal Court of Australia in Australian Securities and Investment Commission (ASIC) v Cassimatis,^[1] directors are found to have been in breach of their duties if they fail to conduct care and diligence which results in the company contravening the law. Similarly, in the Australian Securities and Investments Commission v Healey,^[1] it was held that directors have a responsibility to pay attention to the business of the company. In the making of their opinions, the directors are supposed to carefully read and understand any financial statements in carrying out the roles and functions of a director. Moreover, in ASIC v Hellicar & Ors^[1] and Shafron v ASIC^[1], the High Court of Australia held that directors are culpable for a breach of their duties if they issue misleading statements concerning their company.

A breach of the duty of care and diligence can also be found if the directors cause the company to enter into risky transactions without any prospect of profits. Directors should act in the best interests of all the shareholders (whether present or future). However, the directors will be held personally liable even if they thought that their actions would benefit the company but for an improper purpose (R v Byrnes and Hopwood)^[1]. Directors have a fiduciary duty to not only act in good faith but also in the best interests of the company and for a proper purpose. Rocky, Drago, and Clubber disregarded the survey results which made their exploration activities not commercially viable which led to the exhaustion of the company’s capital resources. Additionally, Rocky was clouded by his optimism as opposed to relying on the report of the survey to make their decisions. The low levels of gold had been considered uncommercial, but the directors continued with their exploration obsessions. If directors fail to exercise a degree of care and diligence required by law, they can be held liable for any losses suffered by their company due to their failure to comply with their duties.

            For Rocky, Drago, and Clubber to have any arguable defence, they must prove that the decision that they made to continue with the exploration despite a survey showing that it was not commercially viable was in good faith, for a proper purpose, and in the best interest of the company. In the Centro^[1] case, the court held that although the directors are expected to accept and rely on the judgment, information, and advice of the management, they can deviate from it if there are proper reasons to query such a piece of advice^[1]. The directors can argue that they honestly believed that continued exploration and mining was in the company’s best interests. Moreover, Rocky, Drago, and Clubber can say that they relied on the business judgment rule^[1]. In specific, they can argue that they made the judgment to continue exploring in good faith and for a proper purpose. Additionally, they can state that they did not have a material personal interest in the subject matter of the judgment. Moreover, the directors have a defence to the effect that they informed themselves about the subject matter to the extent that they reasonably believed that their decision was appropriate. Finally, they can argue that they made a conscious decision meant for a proper purpose and in the best interests of DEF.

The same standards which will be used to establish the breach of directors’ duties will not be the same for Drago as it is for Rocky and Clubber. The reason for that is because of the position that Drago holds is the chief financial officer. By virtual of the position, Drago should have had a higher degree of consciousness to understand that the decision to continue exploring was not in the best interests of the company. In ASIC v Vines,^[1] the Supreme Court of NSW held that the defendant; who was a former GIO officer, failed to act with reasonable care and diligence in the course of AMP’s takeover in 1998-99. As such, although the director’s knowledge and expertise do not limit the duty of diligence and care, a higher duty of care and responsibility is placed on those with specific expertise in a field^[1]. Being the chief financial officer, Drago should have advised that it was improbable that the company would gain anything from the exploration. He should have foreseen that the continued exploration would not be in the best interests of the shareholders. As such, a higher standard of care would be paced on Drago, being the person responsible for the company’s finances and having the responsibility to provide sound advice and judgement as to the commercial viability of the mining activities^[1].

Conclusion

One of the primary legal issues in the case study is whether the actions of the directors of continuing with an exploration despite a survey showing that such a mining activity would not be commercially viable was a breach of directors’ duties. The Corporations Act 2001 and case law have demonstrated that directors must act in good faith, in the best interests of a company, and for a proper purpose. However, the decision made by Rocky, Drago, and Clubber was a breach of the fiduciary duty of directors. The three failed to make their judgement based on the survey but rather engaged in a mining exploration which had been held to have no commercial viability. However, the three directors could have an arguable defence that they were not obligated to follow the recommendations of the survey but instead make a conscious decision concerning the issue. Drago; the chief financial officer, would have a higher level of responsibility because of his position. He should have advised the company as to the chances of it becoming insolvent and the exploration not having any benefits. As such, the same standard of diligence and care applied to Rocky, and Clubber would not be applied to Drago.

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