Indemnity Arrangements for Directors and Officers: Implications of ASIC v King
The Situation: The High Court of Australia has allowed an appeal brought by the Australian corporate regulator, confirming that the definition of 'officer' under Australia's corporations legislation includes any person "who has the capacity to affect significantly the corporation's financial standing", even in circumstances where the person does not occupy a named office in the corporation with recognised duties and rights attached to it.
The Judgment: In Australian Securities and Investments Commission v King  HCA 4, the Court unanimously held that the Court of Appeal of the Supreme Court of Queensland erred in concluding that, despite Mr King acting as the "overall boss" of the MFS Group of companies, he was not an 'officer' of the relevant subsidiary as he did not occupy a formal office within that entity. The Court ruled that the capacity of a person to affect significantly the financial standing of the corporation is to be determined by reference to the facts and circumstances of the relationship between the individual and the corporation. While a person's occupation of a recognised office of power within the corporation is one factor to be considered in that assessment, it is not an essential factor.
Looking Ahead: Corporations and individuals need to be aware that individuals who exercise a degree of control over a corporation such that they have the capacity to affect significantly the corporation's financial standing are officers, even where they do not hold a formal position within the corporation. Immediate implications include concerns about the sufficiency of Directors & Officers Insurance and employment indemnities for senior officers of group holding companies. These arrangements require swift review. This case effectively creates 'shadow officers' and continues the erosion of the 'corporate veil' within corporate groups.
Facts of the Case
The first respondent, Mr King, was the Chief Executive Officer ("CEO") and an executive director of MFS Ltd, the parent company to the MFS Group of companies, some of which were engaged in the funds management and financial services industry.
The second respondent, MFS Investment Management Pty Ltd ("MFSIM"), was a subsidiary of MFS Ltd and the responsible entity for the MFS Group's largest managed investment fund, named the Premium Income Fund ("PIF"). In that capacity, MFSIM entered into a $200 million facility with the Royal Bank of Scotland ("RBS Facility"). The RBS Facility was to be used by MFSIM for the purposes of PIF and was not available for use by other companies in the MFS Group.
In late 2007, funds were drawn down from the RBS Facility by MFSIM at Mr King's direction, $103M of which was used to pay the debts of another entity in the MFS Group. The payment was made in the absence of any agreement, consideration, security or promise to repay in place, with the result that PIF (and indirectly the retail investors of that fund) were thereby exposed to the risk that PIF's money would not be restored to it. At the time of the payment, Mr King did not hold any formal office within MFSIM.
The appeal to the High Court related to ASIC's contention that, in contravention of section 601FD of the Corporations Act, Mr King had breached various duties in his capacity as an officer of the responsible entity. Consistent with the factual findings of the trial judge (which were not disturbed on appeal) that Mr King acted as the "overall boss of the MFS Group" and assumed "overall responsibility for MFSIM", ASIC argued that Mr King came within the definition of 'officer' because he was a person with the capacity to affect significantly MFSIM's financial standing, notwithstanding that he held no formal position within MFSIM at the time of the relevant payment.
An 'officer of a corporation' is defined in section 9 of the Corporations Act to mean (among other things):
(a) a director or secretary of the corporation; or
(b) a person:
(i) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or
(ii) who had the capacity to affect significantly the corporation's financial standing; or
(iii) in accordance with whose instructions or wishes the directors of the corporation are accustomed to act (excluding advice given by the person in the proper performance of functions attaching to the person's professional capacity or their business relationship with the directors of the corporations); or
The Court (Kiefel CJ, Gageler, Keane, Nettle and Gordon JJ) unanimously held that paragraph (b)(ii) of the definition is not limited to those individuals who hold or occupy a named office or a recognised position in a corporation with rights and duties attached to it.
In the joint judgment handed down by Kiefel CJ, Gageler and Keane JJ, their Honours held that, while paragraph (a) of the definition captures individuals who hold a named office in a corporation, paragraph (b) defines 'officer' by reference to the facts of the relationship between an individual and a corporation in relation to the affairs of the corporation. Their Honours opined that it would be extraordinary if individuals who had the capacity to, and actually did, determine the course of a company's financial affairs could evade responsibility for their conduct by the "simple expedient of deliberately eschewing any formal designation of their responsibilities". This was considered significant in the context of the legislative purpose of section 601FD, which was enacted to provide protection to members of managed investment schemes by imposing duties on officers of responsible entities.
Justices Nettle and Gordon agreed with the orders proposed in the joint judgment and further expressed the view that the definition of 'officer' must be read in light of its legislative context and history, "with an understanding that the text is the latest form of legislative response to what has been continuing evolutionary change in corporate structure and governance". Their Honours also adverted to the risk (although not applicable on the facts of the case before the Court) that bankers and other third parties may fall within the reach of one or more of paragraphs (b)(i)-(iii) of the definition of 'officer', for example, lenders managing a company's attempts to work its way out of financial distress.
Five Key Takeaways
- The High Court's decision confirms that the statutory definition of an 'officer of a corporation' extends to a person who has the capacity to affect significantly the financial position of a corporation, notwithstanding that the person does not occupy a formal office with rights and duties attached to it. Whether a person is an 'officer' will turn on the facts and circumstances of each case.
- An individual cannot evade the duties that the law imposes on officers of corporations by simply not taking up a named office or recognised position within a corporation.
- Although the advice given to a corporation by a third party advisor may, if implemented, have the capacity to affect significantly the financial standing of the corporation; the Court's decision does not have the effect that such persons will be held to be company officers. Rather, the focus is on one's capacity to so affect the financial standing of the corporation. That capacity resides in the individual who determines whether or not advice received by the corporation ought to be acted upon. There is a risk that lenders or third party advisors who are closely involved in managing a corporation's finances in distressed situations may fall within paragraphs (b)(i)-(iii) of the definition of 'officer' if those individuals have the capacity to make decisions in that regard.
- The implications of the decision are profound for corporate law and corporate governance structures. Common protections for senior corporate officers will also include Directors & Officers Insurance and employment indemnities (whether general, or in specific Deeds of Access and Indemnity). These should be swiftly reviewed and, if need be, adapted to ensure they are adequate to address the expanded exposure of senior corporate officers.
- The Court's decision constitutes a significant victory for ASIC and other regulators in that it confirms that the pool of potential defendants to regulatory actions against officers can extend beyond the confines of the boardroom, c-suite and other designated office holders. We anticipate that the decision will further fuel the growing wave of regulatory enforcement action that has been so prevalent in Australia in recent times.
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