The Centro Decision: Expecting more from directors
Australian company directors ought to familiarise themselves with the Centro decision
The Centro decision arose from allegations by ASIC that the directors of companies within the Centro Group had contravened various provisions of the Corporations Act 2001 relating to directors’ duties.
ASIC alleged that the Centro Group 2007 annual reports failed to disclose the following significant matters:
- about $2 billion of short-term liabilities, which were incorrectly classified as non-current (in breach of accounting standard AASB 101); and
- about US$1.75 billion of guarantees of short-term liabilities that had been given post-balance date (in breach of accounting standard AASB 110).
ASIC sought declarations that, by approving the annual reports with the above errors, the directors had breached:
- section 344 of the Act, which requires directors to take all reasonable steps to comply with the financial reporting obligations in Part 2M.3 of the Act; and
- sections 180 and 601FD of the Act that require directors and officers to act with reasonable care and diligence.
The defendants relied on the following arguments:
- that the directors were entitled to rely on proper advice and processes – the financial reports had been approved by Centro’s external auditors PriceWaterhouse Coopers (“PWC”) and the internal Board Audit and Risk Management Committee;1
- that it was unreasonable to expect the directors to detect errors that had previously been missed by both PWC and management;2
- the information provided to the directors relating to the financial reports was over 3,000 pages in length and the directors could not be expected to examine this quantity of information in detail;3 and
- the accounting standards relating to non-current liabilities and post balance date events are complex and within a specialised field of knowledge of accountants.4
On 27 June 2011, Justice Middleton of the Federal Court of Australia delivered his decision on liability. His honour stated the central question was (at [13]):
“…whether directors of substantial publicly listed entities 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 director’s knowledge of the company’s affairs, and that they do not omit material matters known to them or material matters that should be known to them.”
Ultimately, Justice Middleton answered this question by rejecting the arguments put forward by the defendants and finding that the directors had breached their duties. In reaching this conclusion the following principles were articulated:
- directors are required to have the financial literacy to understand basic accounting standards, such as the difference between classifying debt as current or non-current liabilities and the requirement to disclose certain post balance sheet date events;5
- directors cannot rely on management for matters which the Act dictates are specifically within the responsibility of the directors, such as approving financial statements;6
- each director must apply an enquiring mind to the review of the financial statements;7 and
- directors cannot rely on ‘information overload’ as a defence – directors must control the volume of information they receive or assign more time to absorb all the information.8
The Centro decision and the above principles provide valuable guidance on the corporate accountability of directors under the Act. It should serve as a reminder to directors to read, understand and focus upon the documents that they approve.
Fundamental to Justice Middleton’s decision was the fact that the errors in the financial reports were so obvious that the finding of negligence was ‘inescapable’.9 In this respect, some commentaries have speculated that the Centro decision may not be applicable to directors in circumstances where they are not faced with similar, glaringly obvious errors.
Justice Middleton’s decision on penalties is found in (ASIC v Healey (no 2) [2011] FCA 1003). Of the eight defendants, the six non-executive directors were not given pecuniary penalties or a disqualification period. Mr Nenna, the Chief Financial Officer was disqualified from managing corporations for 2 years. Mr Scott, the Chief Executive Officer was ordered to pay a penalty of $30,000.
Justice Middleton found that the widespread public attention to the Centro proceedings and the consequent damage to the defendants’ reputations made it unnecessary to order pecuniary penalties or disqualification periods as a means of deterrence in this case.10
The Centro decision explicitly stipulates that directors need to be accountable for their responsibilities under the Act and these responsibilities cannot be delegated to others.