When the risk of doing business may put you at risk of breach of directors’ duties


13 December 2020


The decision in Cassimatis v Australian Securities and Investment Commission [2020] FCAFC 52 is a timely reminder for directors to ensure their business practices comply with the statutory obligation of care and diligence outlined in the Corporations Act 2001 (Cth) (Corporations Act).

 

Background

Mr and Mrs Cassimatis were the founders, sole shareholders and directors of Storm Financial Pty Ltd (Storm), a highly profitable company and holder of an Australian Financial Services Licence (Licence). 

Storm engaged in the business of providing financial advice to wholesale and retail investors. Storm frequently advised clients to invest their funds in accordance with the “Storm Model” which was a high-risk investment strategy backed by marginal loans and loans using the family home as security.

The Storm Model was offered to almost all retail clients in a ‘one-size fits all’ approach irrespective of their circumstances.  The case focused on 11 investors with the following common characteristics:

  • over 50 years old;
  • retired or approaching retirement;
  • limited income;
  • held few assets, generally comprising of their home;
  • limited superannuation and limited savings; and
  • little to no prospect of rebuilding their financial position in the event of suffering significant loss.

The vulnerable investors experienced catastrophic financial losses as a result of investing in the Storm Model.  Some of them were left with loans on their homes, lines of credit and being unable to retire for some time.  The Australian Securities and Investment Commission (ASIC) said that by the time Storm had collapsed in early 2009, approximately 3,000 of its 14,000 clients had been ‘Stormified’.

 

Duty of care and diligence

Directors have a duty to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise in the same position.  ASIC argued that Mr and Mrs Cassimatis had breached their statutory duty of care as directors of Storm by offering a ‘one size fits all’ approach irrespective of a client’s financial circumstances, as there was a strong likelihood of Storm contravening the financial services laws with respect to appropriate financial advice, consequently putting Storm’s Licence, and ultimately Storm’s very existence, at risk.

The primary judge held that Mr and Mrs Cassimatis had fallen short of the required standard of care by exercising their powers in a way which caused or permitted (by omission to prevent) inappropriate advice to be given, when the “consequences of that inappropriate advice would be catastrophic for Storm”.

The primary judge also noted that it would have been simple to take precautionary measures to avoid the use of the Storm Model by vulnerable investors.

 

Risk of doing business or risky business?

On appeal, Mr and Mrs Cassimatis argued that there was no breach of the statutory obligation as the breaches were alleged to have occurred while Storm was a solvent company and while they were the directors and sole shareholders, arguing that Storm’s interests were effectively identical to the interests of them as shareholders and they were entitled to risk their capital as they saw fit.  Further, as holders of all the issued shares, Mr and Mrs Cassimatis maintained they were entitled to choose their (and Storm’s) interest in operating the Storm Model over mitigating other risk such as adverse action by ASIC or litigation by disgruntled investors.

The court unanimously held that Mr and Mrs Cassimatis had breached the financial services provisions of the Corporations Act by advising vulnerable investors to adopt the Storm Model to invest notwithstanding that it was inappropriate for their personal circumstances.

The court also found that Mr and Mrs Cassimatis had breached their statutory obligation to exercise care and diligence by considering their conduct that resulted in the contravention of the financial services laws. Mr and Mrs Cassimatis exercised their powers in a way which caused inappropriate advice to be given by Storm to a group of vulnerable investors.  It was further held that Mr and Mrs Cassimatis, as directors of Storm, held and maintained an extraordinary degree of control, which widened their scope of responsibilities and a reasonable director in the circumstances would have taken some alleviating precautions to prevent the giving of inappropriate advice. 

Mr and Mrs Cassimatis’ argument that Storm’s interests were identical to and limited to the interests of the two shareholders was rejected.  The statutory duty of care is a matter of public concern, not just private rights.

 

It’s not just a risk of doing business

Directors have a duty to take reasonable care to avoid any foreseeable risk of harm to their company.  This includes risk of reputational damage or regulatory action that would result from the company breaking the law. 

This case reminds directors it is not sufficient to argue that a contravention may just be the risk of doing business, or that where the directors are also the sole shareholders, they are entitled to risk their capital as they see fit, or choose their interest as a shareholder over mitigating other risks such as adverse actions. 

As always, making these assessments will require a case by case assessment of what risks are foreseeable, and whether appropriate action has been taken to avoid such risks.

 

 

This article provides general comments only. It does not purport to be legal advice. Before acting on the basis of any material contained in this article, we recommend that you seek professional advice.

 

 

Author:

 

Meegan Prior, Lawyer in our Transactions Team 

Contact
Email: mprior@dmawlawyers.com.au
Direct Telephone: +61 8 8210 2235