CORPORATE GOVERNANCE AND THE DUTIES OF COMPANY DIRECTORS Editor Ian M Ramsay Harold Ford Professor of Commercial Law The University of Melbourne CENTRE FOR CORPORATE LAW AND SECURITIES REGULATION FACULTY OF LAW THE UNIVERSITY OF MELBOURNE 1997 ii Published in Melbourne by The Centre for Corporate Law and Securities Regulation Faculty of Law The University of Melbourne Parkville Vic 3052 Australia Phone:61 3 9344 5281 Fax:61 3 9344 5285 Email:[email protected] Website:http://www.law.unimelb.edu.au/choose.htm National Library of Australia Cataloguing-in-Publication entry Ramsay, Ian M Corporate Governance and the Duties of Company Directors ISBN 0 7340 1343 4 ©1997 The individual contributors (in respect of each of their chapters) and Ian Ramsay (in this selection and arrangement). This publication is subject to copyright. Other than for the purposes of and subject to the conditions prescribed under the Copyright Act 1968 (Cth), no part of it may in any form or by any means (electronic, mechanical, microcopying, photocopying, recording or oth- erwise) be reproduced, stored in a retrieval system or transmitted without prior written permission. Enquiries should be addressed to the publisher. iii Centre for Corporate Law and Securities Regulation The Centre for Corporate Law and Securities Regulation was established in January 1996. Its objectives are to: • undertake and promote research and teaching on corporate law and securities regulation • host conferences to disseminate results of research undertaken under the auspices of the Centre or in other programs associated with the Centre • develop and promote links with academics in other Australian universities and in other countries who specialise in corporate law and securities regulation • establish and promote links with similar bodies, internationally and nationally, and provide a focal point in Australia for scholars in corporate law and securities regulation • promote close links with peak organisations involved in corporate law and securities regulation • promote close links with those members of the legal profession who work in corporate law and securities regulation. The Director of the Centre is Professor Ian Ramsay who is also the general editor of the monograph series published by the Centre of which this monograph is a part. The Centre has an Australian Advisory Board chaired by The Hon Mr Justice Ken Hayne of the High Court of Australia and comprising senior legal practitioners, compa- ny directors and directors of the Australian Securities Commission and the Australian Stock Exchange. The Centre also has an International Advisory Board comprising lead- ing judges and corporate law academics. Previous publications of the Centre include: • Phillip Lipton, The Authority of Agents and Officers to act for a Company: Legal Principles • Ian Ramsay (ed), Gambotto v WCP Ltd: Its Implications for Corporate Regulation • Geof Stapledon and Jeffrey Lawrence, Corporate Governance in the Top 100: An Empirical Study of the Top 100 Companies’ Boards of Directors • Megan Richardson (ed), Deregulation of Public Utilities: Current Issues and Perspectives • Cally Jordan, International Survey of Corporate Law in Asia, Europe, North America and the Commonwealth • Ian Ramsay and Richard Hoad, Disclosure of Corporate Governance Practices by Australian Companies Further information about the Centre is available on the Centre’s Website, the address of which is: “http://www.law.unimelb.edu.au/choose.htm”. The Administrator of the Centre may be contacted on tel 61 3 9344 5281; fax 61 3 9344 5285; e-mail: “[email protected]”. iv v Contents PART I - INTRODUCTION 1. The Corporate Governance Debate and the Role of Directors’ Duties Ian M Ramsay 2 PART II - CORPORATE GOVERNANCE 2. The Defining Tension in Corporate Governance in America Chief Justice E Norman Veasey 16 3. The Role of Corporate Governance Practices in the Development of Legal Principles Relating to Directors Justice Alex Chernov 33 4. Corporate Governance, Corporate Law and Global Forces Justice Michael Kirby 49 PART III - DIRECTORS’ DUTIES 5. Directors’ Duties: The Governing Principles Chief Justice David Malcolm 60 6. The Duty of Care of Company Directors in Australia and New Zealand John H Farrar 81 7. The Duty of Care of Directors: Does it Depend on the Swing of the Pendulum? Robert Baxt 92 8. Directors’ Statutory Duties of Honesty and Propriety Michael J Whincop 125 9. The Role of Nominee Directors and the Liability of Their Appointors Justice E W Thomas 148 10. Shadow Director and Other Third Party Liability for Corporate Activity Robyn Carroll 162 11. Safe Harbours or Sleepy Hollows: Does Australia Need a Statutory Business Judgment Rule? Paul Redmond 185 12. The Perspective of the Australian Securities Commission on the Enforcement of Directors’ Duties and the Role of the Courts Alan Cameron 205 Part 1 Introduction Chapter 1 The Corporate Governance Debate and the Role of Directors’ Duties Ian M Ramsay* Introduction This book explores a number of the important aspects of the corporate governance debate and, in particular, it examines the role of directors’ duties in corporate governance. This introductory chapter is divided into three sections. First, I discuss some of the key issues relevant to the corporate governance debate. I include in this section definitions of cor- porate governance and I identify mechanisms that play a role in corporate governance. In the second section I examine a number of specific issues relating to directors includ- ing the corporate governance implications of the structure of the board of directors. Finally, in section three, I review the role of directors’ duties in corporate governance. Corporate Governance Definitions of corporate governance There are many definitions of corporate governance. A number of definitions refer to corporate governance as the system by which companies are directed and controlled. This is the definition provided by the Cadbury Committee in its Report on the Financial Aspects of Corporate Governance.1 It is also the definition provided by the Working Group on Corporate Practices and Conduct.2 Some definitions of corporate governance are narrow while others are more open-ended. A narrow definition is provided by Professors Shleifer and Vishney who state that corporate governance is concerned with “the ways in which suppliers of finance assure themselves of getting a return on their investment”.3 A broader definition of corporate governance encompasses a range of stakeholders in companies. Professor Prentice states that at its broadest level, the cor- porate governance debate “involves the issue of the relationship between the stakehold- * Harold Ford Professor of Commercial Law and Director of the Centre for Corporate Law and Securities Regulation, Faculty of Law, The University of Melbourne. 1 Committee on the Financial Aspects of Corporate Governance (chaired by Sir Adrian Cadbury), Report (1992) at para 2.5. 2 Working Group on Corporate Practices and Conduct (chaired by Henry Bosch AO), Corporate Practices and Conduct (3rd ed, 1995) at 7. 3 A Shleifer and R W Vishney, A Survey of Corporate Governance, National Bureau of Economic Research Working Paper No 5554, 1996, quoted in W Vessler, F R Kaen and H Sherman, Going Public: A Corporate Governance Perspective, Working Paper, April 1997 at 2. The Corporate Governance Debate and the Role of Directors’ Duties 3 ers in a company and those who manage its affairs (the board of directors)”.4 Monks and Minow define corporate governance as: ...the relationship among various participants in determining the direction and performance of cor- porations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors...Other participants include the employees, cus- tomers, suppliers, creditors, and the community.5 These definitions reflect different perspectives on the functions and role of corporate governance. As Vessler, Kaen and Sherman note: One perspective approaches the corporate governance debate as part of the larger question of how to organize economic activity to achieve more fundamental societal objectives related to equity, fairness, freedom and citizen responsibilities. The other perspective is more narrowly concerned with economic efficiency objectives and, at the risk of exaggeration, considers economic efficien- cy to be an end in itself rather than a means to non-economic societal objectives.6 According to one of these perspectives, good corporate governance should have as its objective the maximisation of shareholders’ wealth. The broader perspective (which might be called the stakeholder perspective of corporate governance) focuses upon com- panies being “socially responsible” and often subordinating profit maximisation to other goals. It can therefore be seen that the corporate governance debate is intrinsically linked to the important question: For whom do directors govern? Do they govern for share- holders or for a broader range of stakeholders? This issue is further discussed below.7 Why is corporate governance an issue? According to Oliver Hart,8 corporate governance issues arise in an organisation whenev- er two conditions are present. First, there is a conflict of interest (or an agency problem), involving members of the organisation; and second, the conflict of interest or agency problem cannot be dealt with through a contract. In relation to the second point, Hart observes that there are several reasons why