Emergence of a standard of reasonable competence for CFOs and other executive officers.

* The implications of ASIC v Vines for executive officers

* The objective standard of reasonable competence

* The expansion of the statutory duty of care and diligence where an officer occupies a position requiring identifiable specialist skill

In a decision flagged

as one of potential importance for the duties of executive officers of companies, His Honour Justice Austin concluded that the statutory duty of care and diligence requires chief financial officers to meet an objective standard of care and diligence, encompassing the special skill that would be brought to that office by a reasonably competent person occupying the position of chief financial officer (CFO).

Significant implications may flow from the decision for director and non-director executive officers alike, including CFOs and other officers who have executive positions requiring 'identifiable specialist skill'. It seems that the positions that would fall within this category potentially include those of chief executive officer, chief operating officer, company secretary, general counsel and other commonly recognised positions in large corporations.

Background

Austin J's judgment, ASIC v Vines (1), arose from an interlocutory hearing on the admissibility of expert evidence as to what a reasonably competent officer occupying the designated position of CFO would do in particular circumstances.

The main proceedings concern allegations by the Australian Securities and Investments Commission (ASIC) that (among other things), in contravention of the former s 232(4) of the then Corporations Law, Mr Vines failed to exercise the degree of care and diligence that a reasonable person in a like position would exercise in the corporation's circumstances. Mr Vines was a director of GIO Insurance Limited and the Chief Financial Officer of the GIO Group. ASIC has alleged that he was, therefore, an 'executive officer' of both GIO Australia Holdings Limited and GIO Insurance Limited (within the definition of that term previously included in s 9 of the Corporations Act). The proceedings are listed for hearing during mid to late April 2004.

ASIC sought to tender affidavit evidence by a man who had been CFO of several large corporate groups on the question of whether, in his opinion and based on his experience as a CFO and knowledge of the practices ordinarily adopted by a CFO, Mr Vines had 'failed to act in any way as would a competent CFO in the position of Mr Vines acting reasonably in the circumstances'.

Counsel for Mr Vines submitted that the evidence was inadmissible on three grounds, including irrelevance. The judgment discussed in this article set out Austin J's reasoning for rejecting the submission that the expert opinion evidence was irrelevant to the main proceedings.

Judgment

ASIC's allegations against Mr Vines relate to the statutory predecessor to s 180 of the Corporations Act 2001 (Cth), namely s 232(4) of the then Corporations Law. Section 232(4) provided that:

   In the exercise of his or her powers and the
   discharge of his or her duties, an officer of a
   corporation must exercise the degree of care and
   diligence that a reasonable person in a like
   position in a corporation would exercise in the
   corporation's circumstances.

(Section 9 of the Corporations Law defined an officer to include an 'executive officer' which was, in turn, defined as 'a person, by whatever name called and whether or not a director of the body..., who is concerned, or takes part, in the management of the body'.)

In broad terms, Counsel for the defendant's main contention was that the expert opinion evidence that ASIC sought to tender was not relevant to the proceedings because s 232(4) did not impose on a CFO any legal duty to which an opinion about what a reasonably competent CFO would do could have any relevance. Central to this submission was the fact that s 232(4) referred to 'care' and 'diligence' and omitted the words 'skill' and 'competence'. On this interpretation, s 232(4) imposed a duty referable to subjective standards and, therefore, the officer's own knowledge, expertise and experience.

Austin J found that the defendant's counsel submission raised the following question:

   whether s 232(4) imposed on an officer of a
   company occupying a position such as chief
   financial officer, any objective standard of
   reasonable competence that might be measured
   by expert evidence as to what a reasonably
   competent officer of that designation would do
   in stated circumstances.

To consider this question, His Honour traced the history of s 232(4) and its ancestors and reviewed developments in the case law on the statutory duty of care and diligence. Key aspects of the evolution of directors' duties of care and diligence observed by Austin J were as follows:

* early case law and commentary suggested that there was no common law standard of the reasonably competent company director, with one famous proposition being that 'a director need not exhibit a greater degree of skill than may reasonably be expected of a person with his knowledge and experience' (2)

* the first statutory duty imposed on directors in Australia was a statutory duty of honesty and diligence introduced in Victoria in 1958, and a corresponding duty was subsequently adopted by all states under the Uniform Companies Act of 1961

* in 1981, there was a very significant expansion of the statutory duty of care and diligence in the then Companies Code--for the first time, the statutory duty extended to all corporate officers, not only directors, including an officer like a non-director CFO

* the significance of this expansion of the statutory duty generally was not much debated in the subsequent cases and academic literature and, by and large, the focus of attention has been on the position of the nonexecutive director

* as the case law on the duties of non-executive directors developed in the early to mid-1990s, the cases suggested that a basic standard of competence for company directors might be emerging, for example, in the form of the duty of a company director to understand the financial position of the company (regardless of his or her financial sophistication and training in accountancy), with key cases in this regard being Commonwealth Bank of Australia v Friedrich (3) and Daniels v Anderson (4) and

* Spigelman CJ had recently drawn from the cases on the statutory duty of care and diligence and insolvent trading a 'core, irreducible requirement of skill' for directors, involving an objective test of 'ordinary competence' or 'reasonable ability' (see DCT v Clark (5)).

Austin J drew extensively on the judgment of the majority of the NSW Court of Appeal (comprising Clarke and Sheller JJA) in AWA Ltd v Daniels (6), as well as the observations made by Rogers CJ at first instance in relation to that case. His Honour found that the observations of Clark and Sheller JJA:

* can be taken as expressing the opinion that the statutory duties of care and diligence encompass an objective standard measured by reference to what a reasonable man of ordinary prudence would do, which is enhanced where the directorial appointment is based on special skill by an objective standard of skill referable to the circumstances and

* impliedly recognise that the directorial duty, the same for executive and non-executive directors alike, may be supplemented by an executive duty in the case of an executive director.

The combined effect of those two propositions led His Honour Justice Austin to form the view that there is now a standard of skill for executive officers who are appointed to positions requiring the exercise of skill, and that this standard of skill is reflected in the statutory formulation of 'care and diligence' (notwithstanding the absence of the word 'skill' in the statutory formula). Justice Austin also observed that, while Clarke and Sheller JJA considered that there is no universal formulation of a standard of skill for company directors, the position is quite different when one is concerned with a designated position, the incumbent of which is appointed because of special skill, such as the position of chief financial officer.

With regard to the specific formulation of the statutory duty in s 232(4) of the then Corporations Law, Austin J concluded that the degree of care and diligence that a reasonable person in 'like position' to the chief financial officer of a corporation would exercise in the corporation's circumstances is the objective degree of care and diligence flowing from the position of CFO, encompassing the special skill that is to be brought to that office.

Implications

While historically there has been a clear tendency for the case law and commentary to focus on the duties of non-executive directors, Austin J's decision in ASIC v Vines has provided a timely reminder of the significant role and responsibilities of non-director executive officers, including CFOs. In particular, the case highlights the fact that non-director executive officers are subject to the statutory duty of care and diligence.

Importantly, the decision shows that (for director and non-director officers alike) the content of the statutory duty of care and diligence will be expanded where an officer occupies a position requiring identifiable specialist skill. Austin J found that, as the position of CFO is a recognised position in large corporations, there is identifiable skill attaching to that office. His Honour did not need to consider which other positions would fall within this category. However, the analysis seems to be equally applicable to other commonly designated positions, such as chief executive officer, chief operating officer, general counsel and company secretary.

Where a person holds an office requiring identifiable specialist skill (like CFO), the officer will be required to meet an objective standard of reasonable competence or skill. Accordingly, to defeat allegations of breach of duty, it will not be sufficient for CFOs or other officers to demonstrate that they honestly performed their roles with the care and diligence that could reasonably be expected of them having regard to their own expertise, experience and knowledge. They may be exposed to liability if they lack the skill and expertise to be expected of a reasonably competent officer in their position.

Although the decision of ASIC v Vines related to the statutory predecessor of s 180(1) of the Corporations Act, Austin J's analysis seems equally applicable to the statutory duty of care and diligence now formulated in s 180(1).

As the decision was an interlocutory one, it will be open to the parties to make submissions at the final hearing of the proceedings that Austin J's analysis was incorrect. However, having regard to the extensive research and analysis that Austin J undertook to form his conclusions on the content of the statutory duty and the breadth of his experience in company law, it seems unlikely that he would form a different view at the final hearing.

Other relevant developments

Broader regulatory developments are also revealing an emerging focus on the critical role played by CFOs (and CEOs) in ensuring sound governance and risk management. In particular, the ASX Corporate Governance Council's Principles of good corporate governance and best practice recommendations (released in March 2003) include recommendations requiring the CEO and CFO to certify to the board that:

* the company's financial reports present a true and fair view, in all material respects, of the company's financial condition and are in accordance with the relevant accounting standards (see best practice recommendation 4.1) and

* the financial reports are founded on a sound system of risk management and internal compliance and control, and that those systems are operating efficiently and effectively in all material respects (see best practice recommendation 7.2).

If enacted, the so-called CLERP 9 Bill (7), which was tabled in Parliament in December 2003, will also effectively impose certification obligations on CFOs and CEOs in relation to their company's financial statements. CLERP 9 provides that the directors' declaration in relation to the financial statements may only be given after the CFO and CEO have provided declarations as to specified matters concerning the financial statements, including that, in their respective opinions, the financial statements present a true and fair view of the financial position and performance of the company and comply with the accounting standards. (8)

Notes

(1) (2004) 22 ACLC 37

(2) In Re City Equitable Fire Insurance Co [1925] Ch 407 at 428-9, per Romer J

(3) (1991) 5 ACSR 115

(4) (1995) 37 NSWLR 438

(5) (2003) 45 ACSR 332 at 355

(6) (1992) 7 ACSR 759

(7) The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003

(8) see proposed s 295A, CLERP 9 Bill

Michelle Milligan, Senior Associate, Minter Ellison Lawyers