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Question:

Discuss about the Business Law ASIC v Adler.
 
 

Answer:

The brief facts of this case are that in June 2000, HIH Casualty and General Insurance Ltd. (HIHC) gave an unsecured and undocumented loan of $10 million to Pacific Eagle Equity Pty Ltd (PEE). The latter corporation was controlled by Mr. Adler, the trustee of Australian Equities Unit Trust (AEUT). At the same time, he was also acting as the non-Executive Director through Adler Corporation which was a major shareholder of HIH. After getting this credit, PEE also became a trustee of AEUT. The loan of $10 million given by HIHC to PEE was used for HIHC's subscription for 10 million worth AEUT Units. Then PEE purchase shares of HIH worth $4 million on the stock market when these shares were put up for sale by PEE at the loss of $2 million. These shares of HIH were bought by PEE for creating a false impression in the stock market, among the investors of HIH that the company is doing good. Similarly, various unlisted shares were purchased by PEE in technology and communication corporations from the Adler Corporation at a price of $4 million. However, all this proved to be a total loss investment. The amount of $2 million was given under trust by AEUT to Adler. However these dealings have been carried out without informing the board of the company and without taking the approval of the shareholders. In the same way, there was no disclosure made to the board or to the investment committee of HIH. Under these circumstances, the court held that in this case, there has been a breach of directors duties mentioned in the Corporations Act by Adler, particularly the duty mentioned in section 180, 181, 182 and 183. As a result of this conclusion, it was decided by the court that Adler should be prohibited from acting as a director of a corporation for twenty years. Similarly, Williams and one more director of the company were also banned from acting as the director for 10 years. Apart from it, penalties were also imposed by the court. Therefore, a penalty of $450,000 was imposed on Adler. A similar penalty was imposed on Adler Corporation. Williams had to pay a penalty of $250,000 and in the same way the other director Fodera was required to pay a penalty of $5000. Apart from it, Adler, Adler Corporation and Williams were also ordered by the court to pay a sum of $7,986,402 to HIHC.

The facts of ASIC v Adler were not only very exceptional, but they were also very complicated. The reason was that in this case, there was involved a number of breaches of the duties of directors prescribed in the Corporations Act. It also needs to be mentioned that the collapse of HIH was the result of very bad corporate governance. These breach of duties included the breach of section 180, which prescribes the duty to act with care and diligence; section 181 that imposes a duty on the directors to act in good faith; s 181(2), which prescribes the business judgment rule as a defense to the directors; s182 which prohibits the improper use of position by the directors; s183 according to which the directors should refrain from improperly using any information received by them consequently of their position in the corporation and s 260A related with financial assistance (Ford and Austin, 1995).

In this case, it was held by Santow J that HIH, and it’s totally owned subsidiary HIHC, as well as the directors of HIH, Adler, Williams and Fodera were liable for the breach of related party provisions mentioned in Chapter 2E, Corporations Act plus the financial assistance provisions that are present in Part 2J.3 when a loan was given by HIHC to a trust that was under the control of the entities related with Adler and at the same time, some of this money was used for purchasing the shares in HIH. At the same time, the court also found these three directors liable for the breach of their duties as the directors/officers of HIH and HIHC under Division 1, Part 2D.1 regarding their involvement in the above-mentioned intransigence, the buying of shares by the trust in some unlisted Internet and technology companies from the entities that were related with Adler and the loans given by the trust to some other companies that were linked with Adler.

 


In this case, it was held by Santow J. that s208 has been breached by HIH and HIHC due to the reason that the sum of $10 million to PEE can be treated as providing a “financial benefit” to PEE and also to Adler Corporation and Adler, falling under s229. The court also stated that for the purpose of the exception provided in s210, the terms of the financial benefits cannot be considered an “arms length”. This conclusion was made, irrespective of the fact whether the initial payment to PEE was made as an unsecured loan or as the resulting trust, as was argued by Adler. Moreover, in the same way, the court held that the subsequent entering into of the trust deed, cannot be treated to be within the arms length exception mentioned in s210 because there were no adequate safeguards in the trust deed in case where a potential conflict of interest was present on the part of Adler and it was considerably one-sided against the company.

In this regard, the court stated that the factual evidence produced in the court was in favor of the conclusion that this transaction was performed at the initiative of Adler and also with the concurrence of Williams. As a result, the court concluded that both these directors were liable for the breach of s209(2) as they were involved in bridging the provisions of s208 by HIH and HIHC.

Under the circumstances, it was stated by Santow J that on the basis of the evidence presented in this case, it can be said that the other director, Fodera can also be held liable for the breach of s209(2) due to the reason of his involvement in the breach of s. 208 by HIH. The court noted the fact that he had adequate knowledge regarding the essential elements of the breach and the attempts made by him later on to distance himself from the transaction did not alter this position though we tried to refer matters to others.

In this case, it was also stated by the court that Adler had breached his duty of care and diligence that has been mentioned in section 180. According to this section, a director or an officer of the company has to use their powers with same care and diligence that  any other reasonable person would have used. Apart from being reasonable person test, s180(2) contains the business judgment rule, which can be used by the directors for the purpose of complying with their duty of care and diligence (Farrar and Hannigan, 1998). Therefore, when the directors are going to make a business judgment, it can be considered that they have complied with this duty if the business judgment has been made in good faith and proper purpose and at the same time it is also necessary that the director did not have any personal interest in it (Paterson and Ednie, 1976). 

On the basis of the facts of this case, the court stated that at that can be held liable for the breach of his duty to exercise care and diligence, because any reasonably careful director in the same position would not have permitted to pay $10 million to PEE that were going to be used for purchasing the shares of HIH. At the same time, the proper corporate procedures and safeguards have been bypassed by Adler. As a result, the court stated that Adler cannot rely upon the protection provided by the business judgment rule. Due to the reason that it was clear that in this case, Adler had a personal interest due to the fact of a significant shareholding in HIH and as a result, it can be said that the business judgment was not made by a very good faith. These facts clearly revealed that the object of Adler. Behind this transaction was to support the share price of HIH.

Therefore, in the end, it can be stated that this case needs to be considered in perspective and the debacle caused by the breach of duties by the directors can be explained with the help of agency theory. After all, the directors are also human beings and they have their own aspirations. Therefore, sometimes there can be a conflict of interest with their fiduciary duties. Some of the directors are the founders of the corporation and they have taken great pains to establish the company. As a result, these directors tend to think that they can deal with the crisis, which is faced by them as there is always some crises or other present in the management of a big company. The directors think that we have been successful in steering through these crises in the past also (Austin and Ramsay, 2013). Similarly it is a very difficult decision to take the company through bankruptcy. All the directors are aware of the fact that in its life, the company has faced similar prices on many occasions and their decision to continue with the operations of the company has succeeded in getting out the company from the mess. However, the law requires that the companies should pay particular attention to managing this type of risks. For this purpose they should adopt appropriate compliance programs and procedures. In the same way, awareness can also be increased regarding such issues by adopting appropriate training programs (Ford, 1978).

For these reasons, it is very important for the company to make sure that it always has good corporate governance. This is an essential director of a company. Good corporate governance allows the company to create trust and confidence among various stakeholders like directors, shareholders and other relevant persons. The value of the company is also increased significantly as a result of good corporate governance and it can sustain the growth of the company. On the other hand, if the company fails to comply with the rules mentioned in the Corporations Act, the company will be held liable under multiple sections of the Act.

 

References

Austin R.P. and Ramsay, I.M., 2013, Ford’s Principles of Corporations Law (LexisNexis Butterworths, 15th ed.) 432

Farrar, John H and Hannigan, B., 1998, Farrar’s Company Law (Butterworths, 4th ed.) 382

Ford H.A.J., and Austin, R.P., 1995, Ford and Austin’s Principles of Corporations Law (Butterworths, 7th ed.) 262

Ford, H.A.J., 1978, Principles of Company Law (Butterworths, 2nd ed.) 345

Paterson W.E. and Ednie, H.H., 1976, Butterworths, Australian Company Law, vol 2 (2nd ed.)

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