Publications / Corporate Advisory

30 Jun 11
The Centro Eight - ASIC turns up the heat on company directors and executives

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On 27 June 2011, the Federal Court of Australia handed down its decision in ASIC v Brian Healey & Ors, which concerned the approval of the erroneous 2007 financial accounts of the highly leveraged Centro Group of companies by its seven current and former directors, as well as the chief financial officer.

In a major victory for the corporate regulator, Justice Middleton found that each director had failed in his duties under the Corporations Act 2001 (Cth) (Corporations Act) by failing to properly analyse the Group’s accounts. ASIC has hailed the judgment as a ‘landmark’ decision in Australian corporate governance. The decision puts the spotlight on a director’s duty of ‘care and diligence’ and the extent to which a director’s reliance on management and external advisers might be reasonable.

The decision has the potential to change the dynamic between directors, management and other corporate advisers in Australian board rooms.

The facts

The case centred on the approval by the board of the 2007 annual reports of both Centro Properties Group and Centro Retail Trust, which misclassified nearly AUD 2 billion of borrowings as non-current liabilities and failed to disclose the existence of approximately USD 1.75 billion in guarantees given over short-term liabilities of an associated company.

The central issue was not that the directors knowingly misclassified the debt, but that they should have known. In approving the accounts, the board relied on the advice provided by Centro’s internal finance team and its external auditors. Neither the chief financial officer, nor the external auditor, alerted the board to issues relating to the classification of the debt or the existence of the guarantees. In fact, a number of board members admitted that they did not read the financial statements in detail before approving them.

ASIC alleged that the directors had breached their duty of care and diligence under sections 180(1) and 601FD(3) of the Corporations Act, as well as their financial reporting obligations under section 344(1).

The decision

The Federal Court of Australia found that each director, in approving the erroneous 2007 annual reports, had contravened his duty of care and diligence (section 180(1)) and his duty to take all reasonable steps to secure compliance with the financial reporting obligations (section 344(1)). The Federal Court also found that the chief financial officer had contravened his duty of care and diligence as an ‘officer’.

Crucially, Justice Middleton held that directors cannot simply rely on their advisers alone when approving company accounts - they must read the financial statements and form their own opinion, noting that ‘such a reading and understanding would require the director to consider whether the financial statements were consistent with his or her own knowledge of the company’s financial position’.

Justice Middleton expressed a view that directors should ordinarily obtain their knowledge of the company’s financial position by:

  • acquiring a basic understanding of the business of the company and the fundamentals of the business in which the company is engaged
  • keeping themselves informed about the activities of the company
  • monitoring the company’s corporate affairs and policies, and
  • maintaining a familiarity with the company’s financial status by regularly reviewing and understanding its financial statements.

His Honour noted the importance of financial reporting in informing the market of a true and fair view of a company’s performance, and held that directors should have ‘financial literacy to understand basic accounting conventions and proper diligence in reading the financial statements’ and that ‘a director, whilst not an auditor, should still have a questioning mind’.

Implications for directors and senior executives

The decision has raised the bar, at least for directors of public companies, as to the standard required in considering and approving a company’s financial reports, and providing the declaration required by section 295(4) of the Corporations Act (i.e. solvency, compliance with accounting standards etc.). It is particularly relevant to non-executive directors, especially those without accounting qualifications.

Justice Middleton noted in his decision,

‘the omissions in the financial statements ... were matters that could have been seen as apparent without difficulty … upon a careful and diligent consideration of the financial statements’.

His Honour stated,

‘this proceeding is not about a mere technical oversight. The information not disclosed was a matter of significance of the risks facing [Centro]. The importance of the financial statements is one of the fundamental reasons why the directors are required to approve them and resolve that they give a true and fair view… The significant matters not disclosed were well known to the directors, or if not well known to them, were matters that should have been well known to them’.

He went on to say that,

‘nothing I decide in this case should indicate that directors are required to have infinite knowledge or ability. Directors are entitled to delegate to others the preparation of books and accounts and the carrying on of the day-to-day affairs of the company. What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to [their] responsibilities’.

The decision provides little guidance to assist directors in understanding where to ‘draw the line’ in terms of the level of enquiry they need to undertake on financial statements. It is clear from the decision that ASIC does not expect directors to ‘get it right’ in all circumstances, but that the directors, in this case, should have detected the error in the financial statements. In particular, in the context of the misclassified debt, reference is made to the fact that the directors would have been aware of negotiations to refinance or extend existing facilities and had received monthly board papers showing the shortening maturity profile of Centro’s debt. For a group of companies reliant on debt to the extent that Centro was at that time, those should have been sufficient indicators for a diligent director to raise the concern.

The difficulty for a director in practice is to sensibly define and understand the extent to which he or she must investigate matters not obvious on the face of material presented by management, possibly due to inadvertence or mistake by management or advisers. On that issue, the lawyers for the directors and chief financial officer argued during the case that an adverse finding would cause the board rooms of Australia to empty overnight. However, Justice Middleton was not perturbed. In a section of his judgment entitled ‘reality check’, his Honour stated that, in his view, the elevation of the standard would not overburden directors, noting that directors are well remunerated and hold positions of prestige and that, despite his ruling, boards would continue to attract competent, diligent and intelligent people.

The interaction between directors, management and other corporate advisers in Australian board rooms may come under increased scrutiny as a result of the decision. Should directors now ‘second guess’ their management and advisers and take on the role of ‘Devil’s advocate’? If so, to what extent is that appropriate? Is such an approach to governance likely to yield better corporate results for shareholders?

ASIC will now seek orders, which might include orders to disqualify the directors and officers from managing corporations, as well as for pecuniary penalties. It will be interesting to see the Court’s approach to any application by ASIC for disqualification in these circumstances, where there is no suggestion of dishonest conduct by the directors - they simply ‘should have known better’.


Financial reports are the cornerstone of a proper assessment of the risks faced by any company. The decision in ASIC v Brian Healey & Ors clearly emphasises this point. As a result, directors should be well versed in basic accounting principles and be conscious of their duty to properly assess and review financial statements. Further, directors should be warned against simply delegating financial reporting obligations to internal or external advisers.

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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