1. In Brief

ASIC v Healey & Ors [2011] FCA 717 concerns the scope of a director’s duty to exercise reasonable care and skill in understanding the financial reports of a company.

2. Facts

The Defendants were 2 Executive and 6 Non-Executive directors of the various Centro companies. During September 2007 board meetings, the directors approved the companies' accounts. The accounts had several serious errors. They:

  • did  not  disclose  around  $1.5  billion  of  short  term  liabilities  (they  were  classified  as  non-current liabilities);
  • did not disclose around $1.75 billion of guarantees of short term liabilities of an associated company; and
  • did not disclose another $500 million of short term liabilities (again classified as non-current liabilities).

Consequently, Australian Securities and Investment Commission (ASIC) alleged that the directors had breached their directors’ duties. Specifically, they breached:

  • section 344 of the Corporations Act 2001 (Cth), which requires a director to take all reasonable steps to comply with, or to secure compliance with, the financial reporting obligations contained in Part 2M.3 of the Act (s601FD(1)(f) is to similar effect); and
  • sections 180(1) and 601FD(1)(b) of the Corporations Act 2001 (Cth), which imposes a duty on directors to act with care and diligence.

3. What the court was required to determine

The court was required to determine the extent of a director’s responsibility for signing off on proposed financial statements.

In particular, whether a director is required to apply his or her own mind and carry out a careful review of proposed financial statements, to determine whether the information contained in the reports is consistent with his or her own knowledge of the company’s affairs.

In summary, the court was deciding the breadth of responsibility a director has to truly read, understand and then approve (or not) the company's financial statements.

4. Decision

On 27 June 2011, Justice Middleton of the Federal Court of Australia found that the directors were in breach of their directors' duties under the Corporations Act. Justice Middleton found that a director cannot simply 'go through the paces' when signing off on financial statements. While a director can rely upon others to prepare the financial statements, the requirements for directors under the Corporations Act does not allow directors to simply discharge the responsibility of accurate financial statements to another competent and reliable person.

A  director  is  required  to  read,  understand  and  apply  his  or  her  own  knowledge  to  financial statements before approving them.

Justice Middleton found that the errors in the accounts were well known to the directors, or if not well  known  to  them,  should  have  been.  On this  basis Justice Middleton  found  that  the directors failed to take all reasonable steps required of them. Consequently, they failed to exercise the care and diligence required by directors under the law and thereby breached the relevant Corporations Law directors' duties provisions.

An argument was raised that the sheer volume of information provided in the financial reports is beyond what a reasonable director can digest and analyse. Justice Middleton rejected this and stated that if a director is provided with too much information in regards to a company, so that they cannot understand all its workings, then the director must decrease the volume of information provided to them or increase the amount of time prescribed to absorb the information.

5. How this decision will affect you

This decision places an onerous task on directors to ensure that financial statements are correct.

Directors can no longer delegate responsibility for the accuracy of financial statements to others. They must have a basic knowledge of accounting concepts and conventional accounting practices. When approving financial statements they must be able to read, understand and apply their own knowledge to the statements and therefore be able to spot possible errors.

As the law now stands, a director bears ultimate responsibility if those statements are not correct and he/she has signed to say they are.

We suggest the way forward until (or if) this decision is challenged, is to:

  • ensure a closer working relationship with your company's financial advisors;
  • ensure  they  prepare  the  financial  statements  in  a  manner  that  you  can  actually  read  and understand; and
  • if required, a refresher course in reading financial statements to ensure that as a director you understand what you are reading before you sign off.

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