On 17 December 2010, the Full Court of the New South Wales Court of Appeal delivered its long awaited judgment in the James Hardie Industries Ltd (JHIL) asbestos litigation. The appeal court upheld Justice Gzell’s first instance decision that JHIL contravened the Corporations Act 2001 (Cth) (Act) by releasing a materially misleading ASX announcement about the adequacy of funding set aside to compensate asbestos victims.1
In a separate decision, the appeal court dealt with Justice Gzell’s findings against JHIL’s non-executive directors and management (Decision).2 The non-executive directors were successful on appeal. On the evidence available, the appeal court was not reasonably satisfied the non-executive directors actually voted in favour of the ASX announcement at the JHIL board meeting in February 2001 (Board Meeting).3
The Decision is illuminating in a number of respects. However, this in-house counsel update focuses on the findings against JHIL’s former secretary and in-house counsel Mr Peter Shafron. Mr Shafron was only partially successful on appeal.
At first instance, Justice Gzell found Mr Shafron had failed to discharge his duties with the necessary degree of care and diligence required as an officer of JHIL under section 180(1) of the Act when advising JHIL’s board on the mechanics of JHIL’s corporate restructure undertaken to separate JHIL’s mounting asbestos liabilities.
The appeal court upheld Justice Gzell’s finding that Mr Shafron participated in decisions of the requisite character to elevate his position to an ‘officer’ of JHIL. Mr Shafron argued his responsibilities as company secretary were purely administrative and did not extend to protecting JHIL from legal risk. The appeal court rejected this distinction, finding Mr Shafron’s role in the restructure went well beyond providing advice or information as required, and can be correctly described as participating in decisions affecting the whole or a substantial part of JHIL’s business.
Draft ASX announcement
ASIC failed to lead any direct evidence that the directors considered and approved the ASX announcement. The appeal court found the ASX announcement had been brought to the Board Meeting but ASIC failed to discharge its burden of proof in establishing that the ASX announcement was passed at the Board Meeting. In this regard the appeal court is particularly critical of ASIC’s failure to call Mr David Robb, JHIL’s key external legal adviser, who was present at the Board Meeting. What occurred at the Board Meeting was the critical factual issue in the case. This decision fundamentally undermined the cogency of ASIC’s case against the non-executive directors.
Given the appeal court was not satisfied the ASX announcement was passed by JHIL’s board, the first instance finding that Mr Shafron failed to advise JHIL’s board at the Board Meeting that the ASX announcement was in too emphatic terms was also thrown out. Usefully, the appeal court indicated that if the board did in fact approve the ASX announcement, it was inappropriate for a reasonable person with Mr Shafron’s responsibilities to have stood by if it appeared the directors were minded to approve a misleading ASX announcement. This is a high standard given the presence of a number of experienced external advisors at the Board Meeting.
Deed of Covenant and Indemnity (DOCI) disclosure
At the Board Meeting, JHIL resolved to enter into a DOCI with JHIL’s former operating subsidiaries, on the basis that the separation of asbestos liabilities would require JHIL to make available additional funds to meet their asbestos liabilities. JHIL failed to notify the ASX of the DOCI shortly after the Board Meeting as required under the Act and the ASX Listing Rules. Justice Gzell found Mr Shafron breached his duty by failing to raise the issue of disclosure of the DOCI for consideration by JHIL’s board. The appeal court upheld the contravention.
Mr Shafron submitted that he was under no duty to point out the obvious requirement of disclosure of the DOCI to the experienced chief executive officer and the board and, in any event, he was entitled to rely on external counsel who was retained to provide disclosure advice. The appeal court rejected both arguments describing the former as ‘particularly unattractive’ and, finding Mr Shafron was not a mere conduit for the advice of external solicitors. He was a senior executive with responsibilities to ensure compliance with regulatory requirements, such as the ASX Listing Rules.
The appeal court noted it was ironic that JHIL management ‘crafted’ the ASX announcement and the related press releases to induce a positive effect on JHIL’s shares, and yet withheld the DOCI information which itself would have had a material positive effect. This indicated the disclosure issue could not reasonably have been overlooked.
Cash flow analysis
In a fresh cross appeal by ASIC, Mr Shafron was also found to have breached his duty by failing to advise JHIL’s board that the ‘best estimate’ contained in an actuarial report on JHIL’s liabilities for asbestos exposure had not taken into account superimposed inflation.
The appeal court held that Mr Shafron, despite not having expertise in the mathematical detail, had primary involvement with obtaining the estimates (likely out of concern for client legal privilege). He also knew that JHIL’s experience was that the cost of claims was increasing at a much higher rate than the general inflation rate. Therefore, a reasonable person with Mr Shafron’s responsibilities would have made sure the board was aware of the limitations of the report.
Lavan Legal comment
Mr Shafron’s relief from liability, pecuniary penalties and disqualification are currently set to be determined in February 2011 after an opportunity for further submissions. However, given the blow to ASIC’s reputation, particularly in relation to the findings against the non-executive directors, there is the distinct possibility ASIC may appeal the Decision to the High Court. Given the findings of a reduction in the flagrancy of Mr Shafron’s conduct we expect there may be a discount in his existing penalty.4
Whilst the non-executive directors were able to secure their exoneration on the facts, the case against Mr Shafron in part succeeded because in-house counsel are uniquely placed to be the focus of regulators. Mr Shafron’s role in JHIL was not atypical. However, in-house counsel will generally function at the heart of the decision-making structure of a company. Furthermore, they are uniquely equipped with the legal knowledge to understand the ramifications of any proposed course of conduct. It is the combination of these factors that means in-house counsel are likely to be held to an exacting standard.
To avoid the risk of personal liability when advising on contentious transactions, in-house counsel must be willing to police the actions of management and maintain clear reporting lines to the board of directors, as the generally accepted ‘directing mind and will’ of the company.
For further information please contact Partner Caroline Brown on (08) 9288 6977 / email@example.com.
1 The first instance decision was handed down on 23 April 2009 in Australian Securities and Investment Commission v Macdonald (No 11)  NSWSC 287. The appeal court rejected JHIL’s appeal in James Hardie Industries NV v Australian Securities and Investment Commission  NSWCA 332
2 Morley & Ors v Australian Securities and Investments Commission  NSWCA 331.
3 The successful directors include JHIL’s chairperson from 2004 to 2007, Meredith Hellicar (56) and former non-executive directors, Michael Brown (65), Michael Gillfillan (62), Martin Koffel (71), Dan O’Brien (55), Greg Terry (66) and Peter Wilcox (65).
4 In Australian Securities and Investment Commission v Macdonald (No 12)  NSWSC 714 Mr Shafron was ordered to pay $75,000 and was disqualified from managing a corporation for 7 years.