A recent Federal Court decision has clarified that directors’ liability for company conduct extends to maintenance of the company’s Australian Financial Services licence.

In Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023 Justice Edelman of the Federal Court of Australia found that Mr and Mrs Cassimatis each contravened s 180(1) of the Corporations Act by exercising their powers in a way which caused or “permitted” (by omission to prevent) inappropriate advice to be given to the relevant investors advised by Storm Financial. Those relevant investors were retired or close to retirement, had few assets, little income, and little or no prospect of rebuilding their financial position in the event of suffering significant loss.

UPDATE: Penalty decision.

UPDATE: Directors lose appeal.

He concluded that a reasonable director with the responsibilities of Mr or Mrs Cassimatis would have known that the Storm model was being applied to clients such as those who fell within this class and that its application was likely to lead to inappropriate advice. The consequences of that inappropriate advice would be catastrophic for Storm (the entity to whom the directors owed their duties). He found that it would have been simple to take precautionary measures to attempt to avoid the application of the Storm model to this class of persons.

Until the Global Financial Crisis in the second half of 2008, Storm was a highly profitable company with $77 million of annual revenue and $120 million of consolidated gross assets.

Justice Edelman concluded that Mr and Mrs Cassimatis should have been reasonably aware that the application of the Storm model would be likely to (and did) cause contraventions of s 945A(1)(b) and section 945A(1)(c). The contraventions of section 945A(1)(b) occurred because Storm did not give such consideration to the subject matter of the advice and did not conduct such investigation of the subject matter of the advice as was reasonable in the circumstances. The contraventions of section 945A(1)(c) occurred because Storm provided financial advice which was not appropriate to the investors having regard to the consideration and investigation of the subject matter of the advice that ought to have been undertaken.

He found those contraventions were not merely likely to occur. They were contraventions which could have (and did have) devastating consequences for many investors in that class and the discovery of those breaches would have threatened the continuation of Storm’s Australian Financial Services Licence (AFSL) licence and Storm’s very existence.

Mr and Mrs Cassimatis submitted that three factors made the case unique: First, the allegations of breach against the directors relied upon a single provision of the Corporations Act 2001 (Cth), without reference to any offence by the company. Section 180(1) imposes a duty to exercise their powers and discharge their duties with “care and diligence”. Secondly, the directors’ breaches of care and diligence are alleged to have occurred while Storm was a solvent company and while Mr and Mrs Cassimatis, as directors, were also the only shareholders. Thirdly, there was no dispute that Mr and Mrs Cassimatis managed Storm in good faith and in accordance with the informed wishes of all the shareholders (themselves).

Mr and Mrs Cassimatis submitted that a director who is the sole shareholder of a solvent corporation could not breach s 180(1) by a course of conduct which was highly likely to contravene provisions of the Corporations Act, or even if he or she intentionally acted in contravention of the Corporations Act. Mr and Mrs Cassimatis relied upon the principle that “where the directors and the shareholders are one and the same, ratification is implicit”. Justice Edelman rejected that proposition.

Justice Edelman’s findings of contravention by Mr and Mrs Cassimatis were based only upon civil, not criminal, breaches of s 945A. No criminal breach of s 945A or s 1041E was proved.

The trial was concerned only with liability. All issues concerning remedies sought by ASIC against Mr and Mrs Cassimatis were deferred to a separate hearing. These subsequent issues include (i) the form of any declarations to be made; (ii) whether the contraventions were serious or materially prejudiced the interests of Storm (s 1317G) and, if so, the amount of any penalties; (iii) any disqualification orders to be made (including the alternative basis upon which such orders were sought under s 206E); (iv) any orders restraining Mr and Mrs Cassimatis from holding an AFSL or providing financial services; and (v) costs.

In discussing the directors’ duty of care and diligence Justice Edelman concluded that directors must think beyond the financial consequences of a particular act by the company and must consider all of the possible harm that may arise – including reputational harm and potentially, the loss of a licence arising from a failure by the company to comply with the law.

“all the corporation’s interests are relevant when considering …the process of balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question…

One reason why the concept of harm should not be confined narrowly is that the overarching question is that of due care and diligence in the exercise of powers or discharge of duties. The broad terms of the legislation do not confine the relevant interests of the corporation which fall for consideration. Further, s 180(1) does not require any proof of actual loss to the company. Harm to its interests including reputation might also occur without prospective loss.

…the scope of possible harm to the corporation ….might extend to unlawful conduct which can cause non-pecuniary consequences for a corporation. ….A corporation has a real and substantial interest in the lawful or legitimate conduct of its activity independently of whether the illegitimacy of that conduct will be detected or would cause loss. One reason for that interest is the corporation’s reputation. Corporations have reputations, independently of any financial concerns, just as individuals do. Another is that the corporation itself exists as a vehicle for lawful activity. For instance, it would be hard to imagine examples where it could be in a corporation’s interests for the corporation to engage in serious unlawful conduct even if that serious unlawful conduct was highly profitable and was reasonably considered by the director to be virtually undetectable during a limitation period for liability.

For these reasons, I conclude that the foreseeable risk of harm to the corporation which falls to be considered in s 180(1) is not confined to financial harm. It includes harm to all the interests of the corporation. The interests of the corporation, including its reputation, include its interests which relate to compliance with the law.

Although these non-financial concerns about legality of conduct are relevant considerations, in this case the potential consequences of the alleged failures to comply with the law were also serious financial threats to Storm including a potential threat to its very existence by the loss of its AFSL.”