Centro Properties Group - Duties Breached by Directors - Case Study Example

Case Analysis — ASIC v Healey & Ors [2011] FCA 717 (Centro Case) Introduction In Australian Securities and Investments Commission v Healey & Ors (Centro case), the Federal Court of Australia stressed upon the responsibility of directors to devote the required attention towards the company’s business. In addition, it was held that directors had to accord due consideration to any advice and exercise their individual judgment in that context. The facts of the case are discussed in the sequel. The financial statement for 2007 of the Centro Properties Group did not provide proper disclosure regarding short-term liabilities to the tune of AU$1.5 billion. These liabilities had been classified as non-current liabilities. Furthermore, there was failure to disclose guarantees amounting to US$1.75 billion relating to short-term liabilities of an associated company. This amount had been given subsequent to the balance sheet date, but before the approval of the financial statements. The primary issue was to determine whether the directors of publicly listed entities were obliged to apply individual judgment to conduct a prudent review of the proposed directors’ report and financial statements, in order to determine whether the information in them was consistent with the directors’ knowledge regarding the affairs of the company. In addition, whether the directors had ensured that they had not omitted material matters known to them or which should have been known to them. In other words, the question related to the extent to which the finance team and audit committee could be relied upon[Del14]. Significance of the Centro Case Decision Consequent to the importance attached to the ruling in the Centro case, the directors of reporting companies have to take into account the ramifications of this decision, whilst reviewing and approving the proposed financial statements. In essence, this decision makes it abundantly clear that directors are under certain obligations that are onerous. Specifically, directors have to ensure the following. First, they must evince intelligent and diligent interest in the information at their disposal. Second, they should make every possible effort to comprehend such information. Third, these directors have to apply an enquiring mind to the responsibilities vested with them[Sch113]. As a consequence, directors have to become conversant with the financial affairs of their company, and this has to be to the extent that is necessary for them to approve the annual financial report competently. In this endeavour, the directors have to necessarily review the details of the proposed financial statements, while applying an enquiring mind. Thus, a certain amount of financial integrity is indispensable for directors. Such competence has to necessarily include the capacity to peruse and comprehend financial statements and basic accounting concepts[Sch113]. Although, the exact extent of such financial knowledge had not been stipulated in this decision, Middleton J declared that directors should possess the financial literacy to understand the basic accounting concepts, such as the classification of liabilities as current or non-current liabilities. ASIC had claimed that the errors committed by the directors were serious and obvious[Sch113]. At the Federal Court of Australia, Middleton J, provided clarification regarding the requirements of directors, vis-à-vis the preparation and dissemination of financial data. He held in the Centro case that directors are authorised to delegate the task of preparation of accounts and books, and the conduct of the usual affairs of the company to others. Nevertheless, directors have to undertake intelligent and diligent interest in the information available to them, comprehend such information, and apply an enquiring mind to the responsibilities vested with them. A responsibility of this nature was deemed to arise with regard to the adoption and approval of the financial statements of the company. In view of the significance and character of such financial statements, it was incumbent upon the directors to comprehend and concentrate upon the information in them. In addition, the directors were expected to undertake further enquiries, if deemed necessary, whenever the information disclosed in those statements warranted such enquiry[Ber13]. Duties Breached by Directors Middleton J held in Centro that the directors had failed to notice the wrong classification of certain amounts of current liabilities as non-current. These directors should have known or could have determined that this amount was payable within the year. The eight directors of this company contended that they had relied upon the external accounting firm, which they had believed to be trustworthy and competent. The learned judge rejected their argument and held them guilty of breach of the Corporations Act 2001, on account of their failure to verify the data in the financial statements submitted by the accounting firm[Aus123]. Section 295(4) of the Corporations Act 2001 directs that the directors of a company have to read with prudence and understand financial statements prior to forming the opinions that have to be stated in the declaration required by this Act. This perusal and comprehension would require the directors to deliberate upon whether the financial statements were in harmony with their knowledge regarding the financial position of their company[Cor16]. Such accumulated knowledge was the outcome of the responsibilities that directors shoulder whilst functioning in that capacity. Some of these responsibilities are; first, directors should possess, at the very minimum, a basic understanding of the business of the corporation and should familiarise themselves with the rudiments of its business. Second, they should remain abreast of their corporation’s activities. Third, directors should supervise the corporate policies and affairs. Fourth, they should undertake regular review of financial statements and comprehend them, in order to remain cognisant with their corporation’s financial status. Fifth, directors should possess an enquiring mind, despite not being auditors[Cor16]. The Centro decision emphasises that the directors of a company have to ensure that the information provided by the company’s management is considered and measured for compliance independently. Thus, the Board of Directors have to adopt a proactive approach towards the financial statements obtained from the company’s management[Ald11]. Under no circumstances, can the directors assume the veracity or completeness of such statements by merely relying upon the word of the management. In addition, Section 344(1) states that a company directors breaches it upon failing to adopt all reasonable measures to secure compliance or to comply with the financial reporting and financial records obligations under the Corporations Act 2001. As such, an important lesson to be learnt by the directors of a company, from the Centro case, is that some duties do not permit delegation to other people, including management or external advisors[Mil16]. Statutory Standard of Care and Diligence Section 180(1) of the Corporations Act 2001 obliges the directors and other officers of a corporation to carry out their duties and exercise their powers with the same diligence and care that reasonable individuals would exercise under the following circumstances. First, they were a director of officer of a corporation placed in the same circumstances. Second, if they had the same responsibilities in the corporation and occupied the office held by the director or officer. Moreover, Section 601FD(1)(b) imposes a similar duty on the officers and directors of a responsible entity[Aus115]. Nevertheless, in the Centro ruling, no reference was made to the business judgment defence available under Section 180(2) of the Corporations Act 2001. The decisions of directors regarding the financial statements were not considered to fall within the scope of business judgments. In fact, Middleton J expressed the standard of care and diligence demanded under Section 180(1) by stating that company directors had to adopt reasonable measures to be in a position to supervise and guide the management of their company[Aus115]. Furthermore, with regard to obvious negligence, directors do not have a reliance defence for its consequences. Section 189 of the Corporations Act 2001 states that reliance upon expert advice, by directors, has to be in good faith and after they have conducted an independent evaluation based upon their knowledge of the company and the complexity of its operations and organisation. The standard of skill becomes applicable to directors who have a personal statutory duty to take a decision, and to the directors of a Commonwealth company, whilst approving the annual report of the company[Aus124]. Conclusion An important fact that emerges from the Centro decision is that directors cannot delegate financial obligations to others. The responsibility and blame for breach of such duties rests squarely upon the shoulders of the directors of the company. Moreover, serious consequences have to be envisaged, when there failure on the part of directors to comply with such duties. Reliance upon others regarding the management of financial affairs of the company renders directors liable for breaches of the Corporation Act. As such, this ruling makes it crystal clear that the directors of a company have to perforce involve themselves in the management of the company. References Alderman, P., 2011. Centro and the lessons for directors. [online] Available at: [Accessed 3 February 2016]. Austin, B., 2012. Directors' duties: some reflections after the James Hardie, Fortescue and Centro cases. [online] Available at: [Accessed 3 Feburary 2016]. Austin, R. & Reynolds, C., 2011. Alert – All reasonable steps to be in a position to guide and monitor' – the impact of the Centro decision. [online] Available at: [Accessed 3 February 2016]. Australian Institute of Company Directors, 2012. Centro: a year on. [online] Available at: [Accessed 3 February 2016]. Australian Securities and Investments Commission v Healey & Ors (2011) FCA 717. Berk, J. et al., 2013. Fundamentals of Corporate Finance. 2nd ed. Frenchs Forest, NSW, Commonwealth of Australia: Pearson Higher Education AU. Corney & Lind, 2016. Centro Case – Director’s Duties – the ‘bar has been raised’. [online] Available at: [Accessed 3 February 2016]. Corporations Act No. 50, 2001. Canberra, Commonwealth of Australia: Australian Government ComLaw. Deloitte & Touche, 2014. The Companies Act. [online] Available at: [Accessed 2 February 2016]. Mills Oakley, 2016. Centro Case- any implications for NFP’s?. [online] Available at: [Accessed 2 February 2016]. Schultz, J. & Barrett, M., 2011. The Centro Decision – Directors’ Duties for Financial Statements. [online] Available at: [Accessed 2 February 2016]. Read More