Popular discussion of corporate law in Australia has recently been dominated by the disturbing findings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. During that government enquiry, Dr Ken Henry, then the Chairman of one of Australia’s largest banks and a former Secretary of Australia’s Treasury, said during cross-examination:
So in the strict letter of the law, as you know, boards are accountable to their shareholders… [But] aspects of the consequences of corporate activity go well beyond impacts on shareholders, and, yet … it’s only shareholders to whom, at law, the directors are accountable. In my view, the public tolerance of that model of accountability has been pretty well eroded to zero.
This idea that boards’ legal duty is to serve the interests of the company’s shareholders is known as ‘shareholder primacy’. With some exceptions, most scholars agree with Dr Henry that this is the foundational theory underlying this aspect of Australian law. But are they right?
From Shareholder Primacy to Reifying the Company
We have reviewed the Australian case law on directors’ duties, noting particularly decisions by the final court of appeal, the High Court of Australia. In our assessment the theory of shareholder primacy does not capture the approach of Australian courts – particularly when more recent cases are considered.
Certainly, in the period from the 1920s to the 1950s there were some judgments in the High Court that characterised directors’ duties as owed to shareholders as a whole. However, with one exception, those statements did not form part of the ratio decidendi of the majority – and hence, based on the law of precedent, were not binding on lower courts. In that one case, the four presiding judges delivered a joint judgment that did endorse the idea that directors must care for the interests of shareholders as a whole. However, that judgment did not address the question of whether the duty might also encompass care for other interests. Since then, a number of appellate decisions have found that directors must also consider the interests of creditors, at least when the company is insolvent or close to insolvency.
In addition to judgments that categorise directors’ duty to the company as a duty that requires attention to the interests of particular groups of persons—that is: the company’s shareholders and, if the company is in financial trouble, its creditors—there is another line of judicial authority in Australia that takes quite a different approach. In several cases, including a 2001 judgment of the High Court, Australian judges have held that the duty is to the company itself and not to shareholders, although they recognise that the interests of the company and the interests of shareholders may intersect. That is: the judges in these cases reify the company and treat it as if it is a physical entity that can have interests of its own.
These cases are consistent with Professor Susan Watson’s ‘entity primacy’ theory,
which she contrasts with ‘shareholder primacy’. Watson has argued that, in many important company law cases in New Zealand and the UK, the courts have characterised the corporation as a ‘fund’ and held that the obligation of directors is to maximise that fund, rather than to look after the interests of shareholders per se.
From Reifying to Anthropomorphising the Company
In the last few years, in litigation involving directors of a company called Storm Financial Limited (‘Storm’), the courts have gone beyond reifying the corporation and have anthropomorphised it. At trial in 2016, the primary judge found that Storm had breached Australian laws regarding the responsible provision of financial advice. The judge also found that, by failing to prevent Storm from breaking those laws, the company’s two executive directors, Julie and Emmanuel Cassimatis, had breached their duty of care as directors. The case was interesting because Mr and Mrs Cassimatis were also Storm’s only shareholders. Their lawyers argued that therefore Mr and Mrs Cassimatis could not possibly have breached their duty to Storm because, in their capacity as Storm’s only shareholders, they had implicitly approved what they had done as Storm’s directors. That is, the Cassimatis’ defence before the court was based squarely on ‘shareholder primacy’.
The primary judge rejected this defence. Instead, he held that, just like people, companies have ‘non-financial’ interests of their own, such as complying with the law, maintaining a good reputation and continuing to exist, and that Mr and Mrs Cassimatis had breached their duties as directors by failing to properly care for those interests. The primary judge’s decision was upheld in 2020 by the Federal Court of Australia’s appellate arm, the Full Court, which endorsed the trial judge’s findings that companies’ have non-financial interests in complying with the law and in continuing to exist. The High Court refused special leave to appeal, on the grounds that ‘there is insufficient reason to doubt the correctness of the reasoning of the majority of the Full Court’.
This anthropomorphising of the company is quite new, and it will be interesting to see how it develops. Arguably, this approach could help reduce the kind of misconduct revealed by the recent Royal Commission into financial services. In his final report, Commissioner Kenneth Hayne expressed disappointment that ‘too often, financial services entities put the pursuit of profit above all else and, in particular, above the interests of their customers, and above compliance with the law’. Australia’s major banks and insurance companies are not alone in this. In recent decades there have been a number of other high-profile scandals where prominent Australian companies have prioritised profits over ethics and/or legal compliance, including AWB Limited, British American Tobacco Australia Limited, Crown Resorts Limited and James Hardie Industries Limited. If Australian directors are required to treat companies as having non-financial reputational and compliance interests, then it will reduce the risk that potential financial penalties for illegal activity will be treated as just another cost of doing business, and it will instead increase pressure on directors to ensure their companies prioritise compliance for its own sake. And that, in our view, would be a very good thing.