Another Reason for ASIC Not to Litigate

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In Short

The Situation: Australia's corporate regulator, the Australian Securities and Investments Commission ("ASIC") brought proceedings against two former directors of Tennis Australia ("TA") alleging that they engaged in numerous contraventions of their duties under the Corporations Act 2001 (Cth) in respect of their conduct during negotiations between TA and Seven Network Holdings (Seven) for a renewal of an agreement for the domestic broadcast rights to tennis tournaments.

The Judgment: In ASIC v Mitchell (No 2) [2020] FCA 1098, Justice Jonathan Beach of the Federal Court of Australia rejected 41 of ASIC's 44 allegations against the directors. Justice Beach was extremely critical of the way that ASIC had brought its case finding that the regulator's case theory displayed confirmatory bias and dismissing its construction of the evidence as based on unsubstantiated "conspiracy theories".

Looking Forward: The Federal Court has delivered ASIC a significant lesson in the risks of the "why not litigate?" approach, with a case which, when viewed through the lens of commercial reality, should not have been brought, instead resulting in many years of litigation and millions of dollars in costs.

The Facts

TA is a company limited by guarantee and the peak body for the sport of tennis in Australia which obtains revenue from fees that it earns from the licensing of rights to broadcast its tournaments. As of 2012, domestic broadcast rights had been held by Seven for more than 40 years with the then most recent agreement with Seven due to expire in July 2014. Seven was granted an exclusive negotiating period from 1 April to 30 September 2013, in respect of any renewal of the agreement.

On 20 May 2013, TA's board unanimously accepted a recommendation from its then CEO Steven Wood to approve a renewal with Seven for five years at a fee which was a substantial increase from the previous agreement.

At the time, two of TA's directors were Stephen Healy and Harold Mitchell, the Chairman/President and Vice President respectively. Prior to the finalization of the negotiations, both Healy and Mitchell were aware of information relating to the interest of a number of other potential bidders for TA's domestic broadcast rights, including Channel Nine and Network Ten. Mitchell had also had communications with the Legal and Commercial Director at Seven that were separate from the negotiations conducted by the CEO.

ASIC's Approach

The judgment is striking for the significant criticism levelled at the way that ASIC had run its case, with Justice Beach noting on multiple occasions that allegations made by ASIC were "spurious" or "untenable". His Honor described the regulator's overall case against the directors as "forensically impoverished". Justice Beach found that ASIC's construction of evidence displayed confirmatory bias noting that it floated various "cover up and conspiracy theories" that ultimately lacked substance. His Honor observed that the effect of such hindsight bias was diminished if one "endeavor[s] to perceive the events as they unfolded in real time appreciating the speed and concurrent conflicting themes and actors at work with different roles, skills, motivations, and objectives".

Crucially, Justice Beach found that ASIC's case theory was flawed from the outset as it did not coherently establish that the conduct of the directors had caused any harm to TA. Instead, the evidence suggested that the renewal deal with Seven was anticipated to be and ultimately was of considerable benefit to TA, with the CEO and the board properly deciding on an informed basis that the benefits of the renewal outweighed the risks of an open tender process.

Breach of Duty Allegations Against Mr. Healy

While the negotiations with Seven were ongoing, certain information relating to the other potential bidders in TA's broadcast rights was not provided to the board, which was a decision taken by the CEO. ASIC alleged that Healy, as chairman, was responsible for disclosing to the board certain information and documents relevant to the interest of the other potential bidders. ASIC argued that by failing to provide such information, Healy breached his duty of care and diligence under section 180 of the Corporations Act.

Justice Beach stated that it is the function of the chairman of a company to preside at board meetings and exercise procedural control, including by setting meeting agendas. However, the Chairman is entitled to set agendas in consultation with the CEO, which may include allowing the CEO to exercise his judgment on what documents should be included in board packs and whether and in what form (i.e. written or oral) certain information should be disclosed to the board.

Justice Beach found that the chairman's duty did not require him to countermand the judgment of the CEO with respect to the information which should be put to the board and the method by which such information was disclosed.

Justice Beach found that given the CEO was charged with managing the negotiation strategy, the CEO was best placed to judge what information should have been provided to the board. The chairman was entitled to rely on this judgment under section 189 of the Corporations Act, which presumes reliance is reasonable when it is made in good faith after an independent assessment has been made. Justice Beach found that ASIC had failed to rebut this presumption.

Breach of Duty Allegations Against Mr. Mitchell

ASIC alleged that, by communicating with Seven's Legal and Commercial Director during the course of the negotiations, Mitchell had failed to act with care and diligence, improperly misused his position as a director, and improperly misused information received as a director, which was in breach of sections 180, 182, and 183 of the Corporations Act.

Justice Beach rejected ASIC's characterization of Mitchell's communications as being made for the purpose of gaining an advantage for Seven during the negotiations. Justice Beach found that Mitchell believed the renewal was in the best interests of TA and rejected any suggestion that there was "conspiracy or collusion" between Seven's Legal and Commercial Director and Mitchell, noting that ASIC was unable to adduce any evidence of such a conspiracy nor advance any motivational reason for Mitchell to engage in one.

However, in respect of three of ASIC's allegations, Justice Beach found that Mitchell "stepped over the line" and breached section 180, including when he twice disclosed TA's internal deliberations to Seven's Legal and Commercial Director and advised him to "hold off" on sending information to the CEO. However, Justice Beach found that these actions were consistent with Mitchell's desire to push negotiations forward, did not have any improper motive, and did not cause damage to TA.

The balance of ASIC's case against Mitchell failed, with Justice Beach suggesting that declarations and a moderate pecuniary penalty, rather than disqualification, might be the suitable consequence. Despite this, ASIC has indicated in a press release following the judgment that it is still seeking a disqualification order against Mitchell in addition to pecuniary penalties.

FOUR KEY TAKEAWAYS

  1. The board is entitled to place reasonable reliance on the judgment and expertise of management. The board's obligation to act in accordance with statutory and general law duties does not require board members to second‑guess decisions taken by management. While a chairman has broader obligations than other non‑executive directors, including the obligation to control the conduct of meetings, they remain entitled to rely on management's view of what information must be provided to the board at meetings.
  2. There is always a risk that regulators or plaintiffs may view the internal management of a company and its board with hindsight bias, with any dysfunction assumed to be attributable to possible misconduct. Mitchell is a case study in the risks of this approach, which can lead to case theories which are wholly inconsistent with the actual intention and actions of the individuals involved.
  3. To mitigate the effect of hindsight bias when evaluating the conduct of company directors, regulators and the courts should endeavor to perceive the relevant events as they unfolded in real time in order to appreciate the speed with which such events occurred, and the numerous concurrent complexities and stakeholders that the relevant directors were required to grapple with in exercising their business judgment.
  4. With ASIC's case against Healy being dismissed with costs and its case against Mitchell a pyrrhic victory, Mitchell is a significant loss for ASIC. ASIC has steadfastly persisted with its "why not litigate?" mantra in the face of a pandemic and a number of high-profile losses, now including Mitchell. The pressure is mounting on ASIC to adopt a more nuanced approach, but in the meantime we expect to see ASIC continue to pursue high-profile cases.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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