Australian Securities and Investments Commission v Lewski

The High Court has allowed in part an appeal against a decision of the Full Federal Court regarding civil penalty proceedings by the Australian Securities & Investments Commission (“ASIC”) against five directors of a failed aged care and retirement trust, concerning whether they breached their duties when they amended the trust’s constitution. It was held that the Full Federal Court erred when it held that certain amendments had “interim validity” unless and until they were set aside, and that the directors had been entitled to act in accordance with their honest belief the amendments were valid. Consequently, the directors had breached various provisions of the Corporations Act 2001 (Cth) to take reasonable care, to be loyal to members of the trust, to not use their position improperly, and to comply with the legal requirements for amendment. However the Full Federal Court was correct to conclude the directors were not “involved in” a contravention of s 208 of the Corporations Act.

A company named Australian Property Custodian Holdings Ltd (“APCHL”) created a unit trust called the Prime Retirement and Aged Care Property Trust (“the Trust”) on 27 December 2000, and was the responsible entity for that Trust. The business of the Trust was retirement villages and aged care facilities.  On 23 July 2001, the Trust was registered by ASIC, as required by s 601EB of the Corporations Act, as a managed investment scheme and the consolidated trust deed became the constitution of the managed investment scheme. The members of the Trust found it difficult to sell their units as there was no secondary market for them.

On 19 July 2006, the four directors of APCHL resolved to amend the constitution of the scheme to introduce substantial new fees payable to APCHL (“the Amendment Resolution”). The members of the scheme did not approve these amendments, nor did the amendments confer any benefit upon the members. One of the new fees was a “Listing Fee” payable once the scheme’s units were listed on the Australian Securities Exchange.

A new director, Mr Clarke, was appointed on 21 August 2006. On 22 August 2006, all five directors resolved to lodge the amended constitution with ASIC (“the Lodgement Resolution”). The amended constitution was lodged on 23 August 2006. In 2007, the directors resolved that the Listing Fee would be paid to companies associated with one of the directors, Mr Lewski (“the Payment Resolutions”).

Pursuant to the Payment Resolutions, APCHL later actually paid cash to itself, and then to one of Mr Lewski’s associated companies, and in units to one of Mr Lewski’s associated companies.

ASIC was unable to bring proceedings in relation to the Amendment Resolution because more than six years had elapsed since the date of the resolution, and it was barred by s 1317K of the Corporations Act. Consequently, it brought proceedings in relation to the Lodgement Resolution and the Payment Resolutions. There were three groups of contraventions.

  1. In relation to the Lodgement Resolution:
    1. Breach of “Negligence Duties”: a breach by APCHL and the Directors of their duty to exercise reasonable care and diligence;
    2. Breach of “Loyalty Duties”: a breach by APCHL and the Directors of their duty to act in the best interests of the members of the Trust and to give priority to the interests of the members of the Trust over their own interests;
    3. Breach of “Improper Use Duties”: a breach by the Directors of their duty not to make improper use of their positions as officers of APCHL, either by directly advantaging APCHL, by providing indirect advantage to persons who would benefit from the fees, or by causing detriment to members of the Trust; and
    4. Breach of “Compliance Duties”: a breach by APCHL of its duty to comply with cl 25.1 of the constitution in varying or attempting to vary the constitution in a manner that resulted in a benefit to APCHL, and a breach by the Directors of their duties to take all steps that a reasonable person that position would take to ensure that APCHL complied with the constitution and the Corporations Act.
  2. In relation to the Payment Resolutions:
    1. Breach of “Loyalty Duties”: a breach by APCHL and the Directors of their duty to act in the best interests of the members of the Trust and to give priority to the interests of the members of the Trust over their own interests;
    2. Breach of “Compliance Duties”: a breach by APCHL of its duty to comply with cl 25.1 of the constitution in varying or attempting to vary the constitution in a manner that resulted in a benefit to APCHL, and a breach by the Directors of their duties to take all steps that a reasonable person that position would take to ensure that APCHL complied with the constitution and the Corporations Act.
  3. In relation to the actual payment by APCHL of the Listing Fee to itself and benefits to companies associated with Mr Lewski:
    1. APCHL contravened s 208 regarding the need for member approval for financial benefit; and
    2. The Directors contravened s 209(2) by being “involved in” APCHL’s contravention.

The trial decision

The trial judge held that the Amendment Resolution was invalid. Section 601GC(1) of the Corporations Act required that an amendment to the constitution that was not made by special resolution of the members of the scheme required the responsible entity to consider whether the change would adversely affect members’ rights. Because the Amendments affected members’ rights, and since APCHL did not consider whether the Amendments would adversely affect members’ rights, the Amendments were invalid. The Directors had no understanding of the Amendment Resolution or the Lodgement Resolution, or of the ramifications of the various fees. They were alerted by their lawyers that there could be issues with the interpretation of the constitution which meant that they may not have power to make the Amendment Resolution, but did not follow up on this.

Consequently, the trial judge found that all contraventions alleged by ASIC were established. However, because Mr Clarke was not a director at the time of the Amendment Resolution, his position was different in some respects. Primarily, he was not expected to have called for the legal advice concerning the Amendment Resolution when considering the Lodgement Resolution at the Board meeting on 22 August 2006. Nevertheless, Mr Clarke remained silent through the meeting, and apparently did not give consideration to the Lodgement Resolutions or Payment Resolutions at all. If he had given proper consideration to the matters before him then he should have understood their deleterious effects, APCHL’s conflict of interest, and the lack of any countervailing benefit to the members for the imposition of substantial additional fees.

The trial judge made 47 declarations pursuant to s 1317E that APCHL and the directors had contravened the Corporations Act. All Directors apart from Mr Clarke were prohibited from managing corporations for various periods of time under s 206C. His Honour ordered pecuniary penalties under s 1317G against each Director.

The Full Federal Court decision

The Directors appealed to the Full Federal Court. ASIC cross-appealed in relation to the adequacy of the pecuniary penalties and disqualifications imposed on the Directors. The Full Federal Court allowed the appeal by the Directors on the basis that the Amendment Resolution had “interim validity” until it was set aside. This meant that although there had been a failure to comply with the requirement for amending the constitution in s 601GC(1)(b), when APCHL lodged the Amendments with ASIC they were effective unless they were set aside.

The Full Court also found that at the time of the Lodgement Resolution and the Payment Resolutions, the Directors were entitled to act in accordance with the constitution which they honestly believed existed, and make decisions accordingly, and that these resolutions were valid. Thus, the Full Court concluded that APCHL and the Directors were not liable for the breaches of duty under ss 601FC and 601FD because they had an honest belief that the constitution had been amended. The Full Court also overturned the trial judge’s finding that Mr Clarke had voted for the Lodgement Resolutions and the Payment Resolutions despite his silence.

Finally, the Full Federal Court found that the directors had not contravened s 209(2) of the Corporations Act by being “involved in” a contravention. According to s 79(c), a person will be involved in a contravention if the person “has been in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention”. To satisfy this, ASIC needed to prove that each Director was intentionally involved in the contravention with knowledge of all of the essential elements of the contravention. However, it was common ground that ASIC could not prove that the Directors knew that the constitution did not authorise the Listing Fee.

As the Full Court allowed the appeals, it did not consider the cross-appeals brought by ASIC and simply ordered that they be dismissed.

ASIC then appealed to the High Court, except in relation to the orders made regarding Mr Clarke.

The High Court decision

The High Court unanimously held that the Full Federal Court was incorrect to hold that the Amendment Resolution had “interim validity”. As noted above, for the amendment to be valid, there were two possible routes APCHL could have taken. The first, s 601GC(1)(a) required a “special resolution of the members of the scheme”, which had not occurred in this case. The second, s 601GC(1)(b), required a decision “by the responsible entity if the responsible entity reasonably considers the change will not adversely affect members’ rights.” (emphasis added).

First, at [48] – [57], the court held that “members’ rights” included “interests” in benefits produced by the scheme, and that accordingly, members’ rights had been affected by the Amendment Resolution.

Secondly at [58] – [63], there was no room for interpreting s 601GC(1) as allowing for “interim validity”. This was for three reasons. (1) The Corporations Act already had other mechanisms to deal with exonerating directors who had honestly believed they had a power to act as they did, including  s 1318 and s 1322(4)(c). (2) The Full Federal Court’s interpretation was in tension with sections such as s 1322(2), which establishes a presumption of validity only in the event of a mere procedural irregularity. (3) Interim validity has never applied to unauthorised amendments to the constitutions of corporations, and there is no reason why statutory trusts of scheme property should not be treated in the same way.

Thirdly at [64] – [78], because the Amendment Resolution was invalid, this necessarily flowed through to the Lodgement Resolution and the Payment Resolutions. The Lodgement Resolution was necessary for the Amendment Resolution to have ultimate effect, and constituted a new act which placed duties upon the Directors and APCLH. In light of this, it was clear that in relation to the Lodgement Resolution, the Directors and APCLH had contravened their Negligence Duties, their Loyalty Duties, their Improper Use Duties and their Compliance Duties. The Payment Resolutions were also subject to Loyalty Duties and Compliance Duties which were also breached by APCLH and the Directors.

Finally at [79] – [88], the High Court upheld the Full Federal Court’s conclusion in relation to the Directors’ liability under s 209(2) for being “involved in” a contravention. ASIC had tried to argue that s 208(3), which stated, “[s]ubsection (1) does not prevent the responsible entity from paying itself fees, and exercising rights to an indemnity, as provided for in the scheme’s constitution under subsection 601GA(2)” was not relevant to the other requirements set out in the section s 208(1). However, the High Court held at [87] that s 208(3) directly related to the circumstances of member approval under s 208(1)(d). Because of this section, the directors did not realise that the constitution did not authorise the Listing Fee, and could not be shown to have been “involved in” a contravention.

Conclusion

The High Court remitted the case back to the Full Federal Court for determination of penalty and disqualification orders, costs, and ASIC’s cross-appeal to that Court. Most of the trial judge’s initial declarations were reinstated, saving those in relation to Mr Clarke, and those in relation to ss 208 and 209.

 

High Court Judgment  [2018] HCA 63 13 December 2018
Result  Appeal allowed in part
High Court Documents ASIC v Lewski
Full Court Hearings [2018] HCATrans 213, [2018] HCATrans 214 17 – 18 October 2018
Special Leave Hearing [2018] HCATrans 191  18 May 2018
Appeal from FCAFC [2016] FCAFC 96 14 July 2016
Trial Judgments, FCA
[2014] FCA 1308 (penalties), [2013] FCA 1342 (liability) 2 December 2014 (penalties), 18 December 2013 (liability)
This entry was posted in Case Pages, Decided Cases, Opinions by Katy Barnett. Bookmark the permalink.

About Katy Barnett

Katy Barnett is an Associate Professor at Melbourne Law School. She was awarded her PhD in 2010, and it was published in 2012 by Hart Publishing as a monograph entitled Accounting for Profit for Breach of Contract: Theory and Practice. In 2013 she was a visiting scholar with Brasenose College, Oxford as part of the Melbourne-Oxford Faculty Exchange.

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