09 December 2005
Key Points:
A director who has specialist business skills must apply them for the benefit of the company, and cannot simply rely on the general business experience of the other board members.
The dynamics of the boardroom can have a significant impact on individual directors' duties, as a recent Queensland court case shows.
Gold Ribbon (Accountants) Pty Ltd was in the business of making unsecured loans to accountants. Its directors were experienced businessmen but, only one of them, Mr Dunn, had extensive experience in the finance industry.
The loan scheme was targeted at the lower end of the accounting profession (particularly accountants who had had difficulty in getting bank loans - the Queensland Supreme Court described Gold Ribbon as being almost a lender of last resort).
The scheme was supported by a bank and an insurance company (HIH). The bank agreed to provide finance, while HIH insured the loans that Gold Ribbon made to accountants.
Gold Ribbon's lending procedures and documentation failed to comply with accepted lending practice:
"The essence of the failure was not establishing a set of procedures under which [Gold Ribbon] would conduct inquiries and obtain evidence with a view to ensuring that loan applicants had the financial capacity to service the loan and repay loan capital. There was a failure also to take measures to ensure that the certification of debts by the borrower was accurate in all relevant respects and that the debts actually existed."
Although he had finance industry experience, Mr Dunn's involvement in the scheme was limited. This came to head in 2001, when the collapse of HIH triggered the termination of the bank facility. Five borrowers defaulted on their loans, and Gold Ribbon went into liquidation. The liquidator sued Mr Dunn for breach of his directors' duties.
The liquidator's case was that Mr Dunn had breached his duty of care to Gold Ribbon by failing to ensure that the company had industry-standard checking procedures in place.
In his defence, Mr Dunn argued that his fellow directors were competent businessmen with a general understanding of basic finance concepts. Because they were executive directors and he was a non-executive, he claimed that he had been justified in leaving the details of the business to them.
Mr Dunn also argued that he had tried to rectify the situation but, because of tensions on the board, had desisted, in the interests of "the dynamics of the board".
Expertise v "knockabout commonsense"
The Court rejected Mr Dunn's defence, on the grounds of his specialist expertise.
He was under a duty to give Gold Ribbon the benefit of that experience and expertise. He was not relieved from this duty by the fact that the other directors were competent businessmen with a general understanding of basic concepts in relation to finance:
"A company is entitled to have all its directors attend to its affairs and to fulfil their respective duties as directors. General business experience and ‘knockabout commonsense’ cannot, of themselves, in circumstances such as those under consideration, equip a director, in the absence of detailed advice based on a full appreciation of the facts, to understand fully the risks inherent in financing and the procedures and mechanisms best suited to overcoming them."
The Court suggested a number of things that Mr Dunn should have done:
Non-executive v executive directors
Nor could Mr Dunn rely on the fact that he was only a non-executive director. According to the Court, the fact that some directors were in executive or managerial roles could not relieve the others of their duties.
Before delegating his functions to someone else, a director should have a reasonable belief that the persons to whom the duty was delegated had appropriate expertise and competence. In this case, Mr Dunn had no reason to suppose that the other directors had relevant expertise. He was entitled to conclude that they were competent, successful businessmen but he knew that he was the only director who had any expertise in finance.
Trouble in the boardroom
Gold Ribbon's board appeared to have been split into factions. There appeared to be some aggression and animosity towards Mr Dunn.
Mr Dunn apparently argued that he had not pressed for a tightening up of the administration of the lending scheme, because it would "rock the boat". This, he said, was a legitimate business judgment and was protected by the "business judgment rule" defence in section 180(2) of the Corporations Act.
However, the Court said that, in order to fall with the business judgment rule, a decision had to satisfy two requirements:
The Court held that Mr Dunn had not done this. He had washed his hands of responsibilities in relation to the affairs of the company generally.
Comment
Except in "one man" companies and some small family companies, directors usually have to interact with each other. This impacts on directors' duties in two ways.
The first is that the board is expected to operate collegially. Each director brings to the board table his own particular skills and knowledge, and has a duty to apply those skills and knowledge - especially if he knows that the other directors and the company are relying on them.
The second is the "don't rock the boat" issue. If the board is hopelessly split and there's a high degree of mutual antagonism, it is tempting for an individual director to take the view that nothing he can do will have any positive effect. Even on well-functioning boards, individual directors may sometimes feel that a particular issue can only be pushed so far. Beyond that, people start to get antagonistic or simply "turn off".
What this case clearly illustrates is that, before deciding to let an issue drop, a director must consider all the relevant facts. In the light of those facts, he must then decide whether letting it drop is in the company's best interests. This will involve balancing the dangers of boardroom tensions against the potential damage to the company if the issue isn't addressed.
For further information, please contact Karen O'Flynn.
