Colin Passmore on legislation affecting directors' duty of care

The Australian courts continue to take the lead in updating the nature of the duty of care which directors owe to their companies. Last year, the New South Wales Court of Appeal in Daniels v AWA (1995) displaced early English law formulations of the scope of directors' duties. These required directors to exercise a level of skill not greater than might reasonably be expected from persons with their individual knowledge and experience. In Australia, we now see a more objective formulation which requires that "directors exercise reasonable care in the performance of their office".

Mr Justice Perry's judgement in State of South Australia v Clark, delivered on 29 March 1996 in the Supreme Court of South Australia, is a further example of the Australian courts applying these standards to directors.

In State of South Australia, the State Bank, incorporated by statute, purchased the whole of the issued share capital of a life assurance company for what turned out to be a grossly inflated value. The State Bank sued its board of directors which had approved this transaction, including its managing director/chief executive officer. Settlements were reached with all of the directors except the CEO.

One of the allegations made against the CEO was that he should not have allowed the purchase to proceed without first obtaining an independent valuation of the target company. This allegation of negligence was based on the fact that the CEO was personally involved in the transaction from beginning to end.

It was clear that the purchase should not have proceeded without a satisfactory independent valuation being obtained and the court held that responsibility for the failure to obtain it rested with the CEO. The court concluded that his failure to see this basic requirement was negligent and that the bank was entitled to damages against him.

The AWA decision has yet to be followed in this country. There appears to be general acceptance that the largely subjective tests developed in 1925 by Mr Justice Romer in In Re City Equitable (1925) for determining a director's standards of skill and care are now outmoded. However, the furthest the English courts have so far gone in an effort to remedy this is to introduce a hybrid objective/subjective test as in the decision of Hoffmann J in Norman v Theodore Goddard (1991). The objective standard is undoubtedly in keeping with the modern ethos and it is only a matter of time before our courts follow the lead being set in Australia.

Colin Passmore is a Simmons & Simmons litigation partner.