FOCUS POINT: THE CENTRO DECISION

ON June 27 in the Federal Court of Australia, Justice Middleton handed down a landmark decision regarding corporate governance practices in Australia which will affect the way that board members conduct themselves in discharging their duties, particularly in reviewing and approving financial statements.

The facts

Popularly cited as the ‘Centro decision’, the Australian Securities Investment Commission (ASIC) sought pecuniary penalties against, and the disqualification of, eight directors of the Centro Properties Group (CNP) for contraventions of s180(1) (directors’ duty to exercise care and diligence), s601FD(3) (duties of officers of responsible entity) and s344(1) (failure to comply with financial recording and financial reporting obligations) of the Corporations Act 2001 (Cth) (the Act).

The core of ASIC’s case was that the director’s breached their duties. The board approved, by resolution, the consolidated financial statements for the 2007 annual reports which had failed to disclose billions of dollars of short-term liabilities for CNP and for the Central Retail Group (CER) by classifying them as non-current liabilities and failed to disclose guarantees of short-term liabilities of an associated company after the balance date.

The director’s argued, among other things, that they were reasonably entitled to rely on the processes which CNP had in place for ensuring that the financial statements were accurate and in accordance with the required accounting standards.

The processes deemed reliable included the engagement of a competent and qualified CFO and the retention of qualified and competent external auditors to audit the financial reports.

The question

The question before Justice Middleton was whether the directors of publicly listed companies are required to apply their own minds to, and carry out a careful review of, the proposed financial statements and the proposed directors report to determine that the information they contain is consistent with the directors knowledge of the company’s affairs and that these reports do not omit material matters known to them, or material matters that should be known to them. A key issue was the extent to which a director rely on the competency of those who deliver information to him.

The decision

Justice Middleton found that as the Act requires the financial reporting processes to be made in accordance with a resolution of the directors, the Act intends to impose ultimate responsibility for those matters upon the directors in a way that they cannot delegate.

His Honour stated that ‘this is not a case concerning the need to verify information or to scrutinise data of a type outside each director’s own knowledge’ but that each director was expected to focus on matters brought before him and to seriously consider such matters, give it critical attention. In other words it is not sufficient to simply go through the motions or solely rely on the advice of others, no matter how competent they may appear to be.

His Honour found that the directors each had knowledge, or should have had knowledge that CNP and CER had substantial short-term liabilities which were required to be repaid or refinanced during that period and by not taking all steps to secure compliance with s295A of the Act and by approving the financial statements, the directors were in breach of s180(1) and s344(1) of the Act.

Implications for directors

The implications of this decision are:

• Directors should possess the financial literacy skills to understand basic accounting conventions and proper diligence in reading financial statements;
• Directors should be familiar and remain up to date with the activities, policies and financial status of the corporation;
• Directors must not simply resolve to approve financial statements or any other resolutions in reliance on the competency of auditors and accountants or other professionals. They must apply their own knowledge and understanding of the corporation in assessing and approving information or risk liability for failing to exercise due care and diligence; and
• Board members should undergo training in corporate governance to understand the full extent of their duties.

Broader implications

With this decision leaving many questioning whether there will be further reaching implications of the Centro decision into other areas of corporate governance, directors will be beginning to question whether these heavy obligations are burdens they are willing to bear.

If these obligations remain or are further conveyed to other corporate governance areas, companies may struggle to find competent, experienced and skilled directors who are willing to rise to the challenge. The flow on effect may put pressure on organisations to offer more competitive remuneration packages to recruit and retain the best.