Am I at risk of a civil penalty?

While ASIC had requested a 5-year disqualification from acting as a director, Finkelstein J held that that was not enough and stated:

“My real concerns here are with punishment for retributive purposes and a general deterrence, but principally the latter. Indeed, general deterrence is of primary importance in cases of this kind. A message must be sent to the business community that for white collar crime the game is not worth the candle…” (p 68)

What is the Civil Penalty Privilege?

The civil penalty privilege forms part of the privilege against self-incrimination. It is intended to protect an individual from being forced to provide evidence which would lead to establishing a liability to pay a financial penalty or incur some other detriment.

The rationale for the privilege is therefore a simple one viz that it is for the applicant to prove its own case (usually a public regulator – ASIC, the Fair Work Commission or the ACCC etc.) and that the director or executive in question should not be forced into a position of furnishing evidence against him or herself that would lead to the imposition of a penalty.

Executive exposure to civil penalties

There are now many provisions in the Fair Work Act 2009, the Corporations Act 2001 and the Competition & Consumer Act 2010 which may expose directors and executives to financial and other penalties.

These penalties are designed to act as a disincentive for bad behaviour. Pecuniary penalties in particular are intended to be punitive and not merely protective of the community.

The focus of the discussion below will be on those civil penalties in the Corporations Act 2001.

Civil penalties under Corporations Act 2001

Section 1317E of the Corporations Act 2001 sets out a long list of breaches of the Act which attract civil penalties. At the top of this list are prohibitions against:

Failing to act with care and diligence – i.e. directors and executives failing to act with care and diligence in the observance of their duties (section 180 (1));

Failing to act in the best interests of the company as a whole – i.e. directors and executives putting their own interests or that of a third party first or oppressing a minority shareholder (section 181 (1));

Improper use of an executive position – i.e. directors and executives using their position to gain an advantage for themselves or a third party (section 182); and

Improper use of company information – i.e. directors and executives using company information which is not in the public domain for the purposes of advantaging themselves or others (section 183).

This is nothing more than a small sampling of provisions which might attract civil penalties which appear in the Corporations Act 2001. However, these four prohibitions are some of the most commonly raised allegations made against current or former directors and executives.

These sections do contain exculpatory provisions that rely on the “Business Judgment Rule” and honesty defences. This is considered in the discussion below on the steps to take to minimise the risk of exposure to civil penalties.

Court Declaration of Contravention – disqualification from being able to manage

Where a court makes a Declaration of Contravention (section 1317E) that there has been a breach of any legislative obligations by any director or executive, this opens up a variety of penalty outcomes.

This can range from disqualification from acting as a director or officer of the company, suspension of an Australian Financial Services Licence, a banning order for financial services licensees, cancellation of license registration as auditor or liquidator and the imposition of a pecuniary penalty.

For most executives, the most serious consequences would be disqualification from being able to manage a Corporation under Part 2-D.6 of the Corporations Act 2001 and the prospect of the imposition of a financial penalty.

Pecuniary penalty orders

Pecuniary penalty orders under section 1317G have the potential to be savage. They are usually calculated by multiplying the value of the penalty – currently $222 – by the number of units for the particular offence under the relevant legislation. The value of the unit is automatically adjusted every three years.

Failing to act with care/diligence and in company’s best interests – misuse of position/company information

As noted above, some of the most common breaches of the civil penalty provisions involve failing to act with care and diligence, not acting in the best interests of the company as a whole and misusing an executive’s position or company information.

Section 1317E makes these breaches – along with a long list of others – require a court to make a Declaration of Contravention.

This may expose an executive to a penalty of up to 5,000 units as well as an additional amount equal to 3 times the benefit obtained/detriment avoided. Similarly, for a corporation, it may be up to 50,000 penalty units as well as an amount equal to 3 times the benefit obtained/detriment avoided.

Clearly, the imposition of any such penalties at the higher end would have the potential to financially ruin most executives.

The Federal Court has, of course, a discretion as to the size of the penalty that can be imposed.

In the decision of ASIC v Adler (No 5) 42 ACSR 80, the Court stated that the factors leading to a penalty order in the lower range of $20,000 – $40,000 included the defendant’s awareness of the impropriety of the action, that there was no intention to deprive the company permanently of funds, the amount in question was not large, there was no deliberate falsification of accounts, and the conduct in question was not egregious etc.

The factors leading a court to order a lower range of penalties might include remorse and contrition shown, efforts to repay any misappropriated funds, acting upon the advice of professionals, not contesting the proceedings, and not involving dishonesty but rather negligence/carelessness, previous unblemished character etc.

In circumstances where the court makes a finding regarding penalty, there would also be the added risk of orders regarding the payment of the costs of ASIC etc. You would also face the cost of having to pay your own unreimbursed legal expenses.

Clearly, even if the penalty were at the lower end of the range, the exposure to legal costs could easily be measured in the thousands or tens of thousands of dollars.

In addition to the imposition of civil penalties and costs, it is also possible for the court to order compensation in favour of the employer that has arisen out of the breach of the civil penalty provision (section 1317H). The company has no obligation to mitigate its loss by seeking recovery from third parties in order to obtain a compensation order under this section.

MacDonald v ASIC [2007) NSWCA 304

In MacDonald’s case, the Court held that, in considering any monetary penalty under section 1317G (noted above) or any disqualification order, this did not abrogate privilege against self-exposure to a penalty. In addition, the executive should not be compelled to include in his defence any material which had the tendency to expose him directly or indirectly to the penalties being sought by ASIC.

Modification of Civil Penalty Privilege – Section 1349 Corporations Act 2001

Shortly after the decision in MacDonald’s case, there was an amendment to the Corporations Act 2001 which sought to restrict the operation of the privilege.

Essentially, the section now states that, in proceedings regarding breaches of the Corporations Act 2001 or the ASIC Act 2001, a person cannot refuse to answer questions, or produce documents etc. on the grounds that the information or document in question might expose a person to a civil penalty.

However, it is clear from the section that it relates only to disqualification orders and suspension of licence holders and banning orders for financial services licensees etc. but no other penalty order.

In other words, these amendments have resulted in the removal of the penalty privilege in relation to disqualification proceedings but not with respect to those proceedings which could result in the imposition of a pecuniary penalty.

Volunteering information without prior advice – may result in loss of privilege

In circumstances where it is alleged that you have breached a civil penalty provision which might involve the imposition of a pecuniary penalty, then you should not reply without first obtaining prior legal advice. It may still be possible for you to invoke the civil penalty privilege as it relates to a pecuniary penalty.

Six-year limitation rule (section 1317K)

In addition, you should be mindful that, under the Corporations Act 2001, ASIC has up to 6 years after the contravention to seek a court ordered declaration of contravention. There is therefore ample time for ASIC to “go after you” long after you cease to be involved with your current employer.

Adopt a defensive strategy

As a director or senior executive of a company whether privately owned or publicly listed, you do not have to be guilty of insider trading to find yourself in a similar position to that of Mr. Vizard. Facing the risk of disqualification, pecuniary penalties, compensation claims from your employer and costs orders etc. would be calamitous for most people.

For a senior executive participating in the management of a business, modern corporation law demands of you a great deal. The “jump bar” is set high.

As noted earlier on in the discussion, the intention of the civil penalty system is to promote “good regulatory practice”.

As part of a risk minimisation strategy, you should therefore be very mindful of not breaching your obligations relating to company information and fidelity. You should therefore be mindful of the following:

Don’t misuse your position or company information

Don’t make improper use of company information or take advantage of your executive position or participate in the decision-making process that may have that effect (section 182/183).

Make sure you pass the “business judgement” test

In addition, you have an obligation to exercise care and diligence under section 180 of the Corporations Act 2001. However, that obligation is discharged if you are able to demonstrate that you have made a “business judgment”.

The question of what amounts to a business judgment is complex and would justify separate treatment of its own. However, in a nutshell, the term “business judgment” is defined in section 180 (2) of the Act.

The statutory definition of this term states that it means any decision is:

(i) made in good faith;

(ii) for a proper purpose;

(iii) in which you do not have a personal interest;

(iv) where you have reasonably informed yourself about the issues; and

(v) rationally believe that the judgment you have arrived at is in the best interests of the company.

Where you are called upon to make a decision that may receive a hostile reaction from other executives, Board directors or minority shareholders, then you should be taking careful file notes of how you were able to satisfy each of the elements in the business judgment definition.

You should also consider obtaining appropriate accounting or legal advice which confirms that there was no question of any impropriety in your decision and that the proposal is not materially prejudicial to the interests of the company and indeed is in its best interests.

If the company refuses to obtain any independent accounting/legal advice of this nature, and the proposal in question is prejudicial to the company and questionable ethically, then you should prepare a memo to that effect addressed to your manager disassociating yourself from that decision.

Pay careful attention to any proposal that calls into question “business judgment” if you are sitting on the Board

If you are sitting on the Board, it would likewise not be prudent for you to vote in favour of any proposal that would not pass the business judgment rule or prevent you from sheltering behind the honesty defences.

Pay careful attention to the minutes of the Board meeting which should confirm your objections and that you did not vote in favour of any questionable resolution.

If, upon receipt of the minutes from the Company Secretary, you find that they do not adequately state your objections, then you should immediately write to the Company Secretary requesting their amendment.

If that is refused, then list on the agenda for the next Board meeting a discussion relating to the inaccuracy of the previous minutes and a proposed resolution amending the inaccurate minutes.

Conclusion

The regulatory burden on the modern executive is formidable and the risk of disqualification and financial penalties should always be top of mind.

The focus on this article is on the civil penalty consequences of failing to act with due care/diligence, not acting in the best interests of the company and misusing an executive position/company information. These are some of the most commonly breached sections of the Act. However, you need to be aware that there are also many other sections of the Corporations Act that have civil penalty consequences.

Previously, the civil penalty privilege was a very useful “umbrella” under which an executive could shelter. However, this has been eroded by amendments to the Corporations Act 2001 (section 1349) as it relates to disqualification/suspension.

Nevertheless, where there is a risk of a pecuniary penalty, the umbrella is still available, but the protection could be lost by inadvertent waiver. In the face of any allegations, an executive must decide early on whether to claim the privilege or waiver it.

Ultimately, the best defence to any alleged breach of legislative obligations under the Corporations Law is that you acted in good faith and are able to satisfy the other requirements of the “business judgment” test.

Your “antenna” should be constantly active. Where your intuition tells you that the company is about to embark upon an important decision that could be subsequently called into question, then object in writing. The documentary evidence should be that you objected to the decision, believed that it was not in the company’s best interests and that you recommended a different course of action.