The Federal Court again puts its faith in disqualification - long after the fact - to deter future negligent conduct by directors, writes Professor Pamela Hanrahan.
The recent win by the Australian Securities and Investments Commission (ASIC) in the Full Federal Court, in Cruickshank v ASIC [2022] FCAFC 128, was probably unsurprising. The case applied the principle that directors of an ASX listed entity should be publicly accountable if their decisions lead to a breach of the company's continuous disclosure obligations. However, it is worth reflecting on the case for what it says about how disqualification is used by the Federal Court for its stated purpose of general deterrence.
A disclosure failure
The events in Cruickshank occurred in September 2015. A listed company, then called Antares Energy Ltd, announced to the ASX that it had entered into two agreements to sell its major oil and gas assets in Texas to an unspecified "private equity purchaser". The sales were expected to realise US$250m and came at a time when Antares' financial future was uncertain.
The share price quickly rose from $0.09 to $0.31. Inquiries from the ASX resulted in a "clarification" announcement three days later and the share price hit $0.50. This was accompanied by a huge spike in daily trading volumes. ASIC launched an investigation into Antares' market disclosure over the week and eventually commenced proceedings against Antares and its chair and CEO, James Cruickshank.
The gist of ASIC's concern was that Antares had failed to disclose three crucial pieces of market-sensitive information. The first was the identity of the purchaser, Wade Energy Corporation. The second was that Antares had not independently verified the capacity of Wade to complete the acquisitions, and the third that Wade had informed Antares it was yet to secure the funding for the one of the acquisitions.
These omissions were found, on the basis of expert evidence as to materiality, to have breached Antares' continuous disclosure obligations.
The case against Cruickshank followed the usual playbook for continuous disclosure failures. ASIC alleged that he had been involved in Antares' contravention and - or in the alternative - he had been negligent in performing his functions as chair and CEO in connection with the disclosure. ASIC failed on the first claim, but succeeded on the second. This is where it gets interesting.
Involved or negligent?
Involvement liability is a form of accessorial liability. A director is involved in their company's contravention if, among other things, they have been "in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention". The effect is that the director is liable on the same basis as the company. However, to establish accessorial liability ASIC must show that the director had actual knowledge of the technical elements or components making up the company's contravention. This is a high bar, and one ASIC has rarely met.
The alternative claim in negligence is a form of direct, rather than accessorial, liability. A director is punished for their own failure to take reasonable care if it exposes their company to the foreseeable risk of adverse consequences (such as ASIC proceedings or a securities class action) that could flow from its failure to meet the continuous disclosure obligations.
The merits of this stepping-stones approach to directors' duty of care in section 180(1) of the Corporations Act 2001 (Cth) has been debated many times - including by the Full Court in the appeal in the Storm Financial case, Cassimatis v ASIC [2020] FCAFC 52. But stepping-stones is now established law and clearly extends beyond continuous disclosure failures to other disclosure and compliance failures by listed and unlisted entities.
The sting, of course, is that decisions about disclosure and compliance made by boards are not business judgements covered by the business judgement safe harbour for directors in s 180(2) of the Corporations Act 2001 (Cth).
Director disqualified
At trial, Justice Katrina Banks-Smith found that Cruickshank "knew of, approved and authorised the release to the market" of Antares' ASX announcements. He knew the significant information and did not disclose it, and his decision-making fell short of the standard expected of a reasonable person in his position. She rejected his submission that he was concerned that, had Wade's identity been disclosed, it might have walked away from the deal.
Cruickshank's breaches "involved a failure... to properly listen, acknowledge or turn his mind to matters including: the matters being raised by the ASX; the scope of Antares' disclosure obligations and whether there was any enforceable confidentiality undertaking; the materiality of the information known by Mr Cruickshank that was not disclosed to investors...; and the potential for this information to affect an investor's perception of risk" that Wade would not complete. Justice Banks-Smith also considered "the apparent failure to obtain or consider independent legal advice as to disclosure obligations in the circumstances to be significant".
In August 2022, the Full Court upheld her Honour's decision to apply a $40,000 civil pecuniary penalty and to disqualify Cruickshank from managing corporations for four years, beginning in November 2021.
It rejected his submission that the period was inappropriate given that five years had already elapsed since the disclosure breach, noting that "there was nothing prior to the... disqualification order which prevented Mr Cruickshank from continuing to serve as a director". Of course, this demonstrates exactly the problem with enforcement proceedings that conclude long after the behaviour has occurred.
Deterring bad decisions
Justice Banks-Smith acknowledged that Cruickshank's conduct "was not deliberately wrongful or dishonest". There was no finding of actual knowledge for the purpose of involvement liability. There was no disclosed history of other contraventions and no finding of improper personal gain. However, she concluded that the conduct in question was not inadvertent and involved a degree of deliberate decision-making on Cruickshank's part.
His disqualification was intended to "serve the purpose of protection of the public whilst also acting as specific deterrence to Mr Cruickshank". Banks-Smith decided it would "also serve the function of general deterrence, communicating the need to uphold proper standards of corporate behaviour, and reflecting the significance of the purpose of continuous disclosure obligations to the market generally. Those standards are apparent from sources including the Listing Rules and it is expected that directors be familiar with how and why they operate".
The Federal Court has a longstanding view that general deterrence is "as important in cases of neglect or carelessness as in cases of misfeasance" and that it "is applicable to those who might be minded to adopt a passive role". By proceeding against Cruickshank, ASIC has underlined its view that directors and officers who actively insert themselves into disclosure or compliance matters must exercise care in making decisions about them.
