ASIC tests director safeguards

The civil penalty proceedings that ASIC has commenced against the former non-executive directors (NEDs) of James Hardie have surprised many observers. On closer analysis, however, they herald no revolution in NED liability.

In his 2004 report, David Jackson, QC, found it "striking" that the proposal put to the Hardie board to approve the separation of the asbestos subsidiaries from the group contained no substantive discussion of the quantum of future asbestos liabilities.

He found nothing in the board papers that would provide any satisfactory basis for identifying what those liabilities might be.

His recommendations, however, focused on the announcement that the Hardie chief executive Peter MacDonald made to the ASX about the separation. He found its statement that the former subsidiaries were "fully funded" and the implication that this funding had been checked by independent experts seriously misleading.

ASIC's proceedings also focus on the ASX announcement rather than the separation and funding decisions themselves. They seek to extend the liability net beyond MacDonald to the NEDs who approved the announcement.

The announcement quoted MacDonald saying: "The directors of James Hardie are satisfied that the Foundation will have sufficient funds to meet all future claims." ASIC alleges the NEDs breached their duty of care by failing to query the draft announcement since they neither believed as individuals that funding was sufficient nor had adequate information before them to justify such a belief.

Further, ASIC says, the NEDs should have known that the ASX announcement was false or misleading since it relied upon a cashflow model whose dubious assumptions were not tested in the limited external scrutiny it was given. They breached their duty of care, ASIC claims, by failing to inquire as to the nature and limits of the external scrutiny and the model's suitability.

It is only in the second aspect of this claim that a question of general application to NEDs arises. The directors' duty to inquire into the basis of a management proposal put to them was made explicit in the AWA appeal decision in 1995. It was later qualified by statutory rights of reliance and delegation, subject to conditions. Those rights are likely to be invoked here.

ASICs other claim similarly turns upon the NEDs' beliefs and intentions, but adds the misleading effect of their concealment.

The Hardie board approved the Information Memorandum for the scheme of arrangement that saw a new Dutch company, JHINV, substituted as the ultimate holding company of the group.

ASIC claims that the scheme proposal falsely represented that the former group holding company could call upon JHINV at any time to make payments upon partly paid shares (PPS) subscribed as part of the scheme. In fact, ASIC claims, some or all of the JHINV directors intended to cancel the PPS after the scheme was effected. The PPS and the call obligation of almost $2 billion were cancelled gratuitously 18 months later.

Jackson found the cancellation of the PPS was "almost inevitable" after the scheme of arrangement and that it destroyed any hope for recovery by asbestos claimants if claims were successful against the former Australian parent.