Directors’ reliance on professional advice – (Apple Fields updated)

In an update to my February note on the FMA’s prosecution of the directors of Apple Fields under the Financial Reporting Act 1993 for failing to deliver financial statements and an auditor’s report to the Registrar of Companies for the financial years ending 2011, 2012 and 2013 – leave to appeal has been granted by the Court of Appeal.

The issues on appeal were those of whether the directors took “all reasonable and proper steps” to ensure compliance with section 18 of the Financial reporting Act 1993 – which requires the directors to both:

• take all practical steps to ensure compliance (such as the efforts to appoint auditors and to obtain the [Noble] accounts); and

 

• to seek comprehensive legal and/or accounting advice as to the range of options available to them when those practical steps did not bear fruit.

The judge at first instance in the District Court reasoned, with reference to section 138 of the Companies Act, that directors might sometimes rely on professional advice.  But in this case she found that:

• the directors did not take further accounting advice because they did not want to file financial statements that excluded the potential profits from Noble, without which Apple Fields might not be a going concern; and

 

• the directors ought to have taken legal advice on whether they could compel Noble to deliver the necessary financial information.

 

Did the appellants act reasonably by not seeking a second opinion about the need for consolidation?

 

The judge at 1st instance found that the directors honestly relied on their accountant’s advice, which they were right to take seriously, and made diligent efforts to obtain information from Noble with a view to consolidation.  That being so, the Court of Appeal judgement states that they must be taken to have acted reasonably, unless a second opinion ought to have been sought in the circumstances and there is reason to suppose that it might have resulted in advice that consolidation was not required.

 

Pleasingly, the Court of Appeal appears to reject the FMA’s stance, that a second opinion might be needed even if the original advice was correct (from a top-tier firm, because de-registration is a serious matter) as preferring process to substance.

 

The court noted its opinion that it matters not how many professional opinions were taken in this case, so long as the directors prove that the advice was correct.  Of course this is not to deny that a second opinion may be needed where the first one is or may be wrong and there is reason to suppose that the directors ought not to have relied upon it without further inquiry.  Nor is it to suggest that directors can hide behind professional advice about things they ought to know for themselves.

 

On the facts, the Court of Appeal did not accept that the appellants chose to rely on their advice because they wanted to avoid a qualified audit.  That assumes they may have doubted its veracity or accuracy and chose not to get a second opinion, a conclusion that is irreconcilable with the findings of the judge at 1st instance that they honestly relied on the professional advice, properly considered it should be taken seriously, and diligently went about trying to follow it.

 

Nor, was there good reason to suppose that a second opinion would have differed from the first.  The Court of Appeal declined the FMA’s invitation to infer that the advice was wrong because NZ IAS 27 was the applicable standard at the time and, based on previous years’ financial statements, financial statements that did not consolidate Noble would nonetheless have been GAAP-compliant.  Its reasons were:

 

• First, one might think it unsurprising, as a matter of common sense, that an auditor would insist on consolidation; after all, Apple Fields was not a going concern without returns from Noble.

 

• Secondly, the only evidence that non-consolidated statements would have complied with the existing standard was displaced by the balance of evidence confirming that consolidation was necessary and that Noble was a “deemed subsidiary” and ought to have been consolidated.

 

• Third, there is no evidence that the directors’ adviser was wrong in his opinion that, once aware of the proposed new standard an auditor might properly insist on taking it into account, making it still more likely that consolidation would be unavoidable if the financial statements were to be certified at all.

 

As a result, the Court of Appeal concluded, differing in this respect from the Courts below, that the directors acted reasonably by pursuing consolidation, rather than separate but qualified financial statements, in reliance on their adviser’s opinion.

 

Did the appellants act reasonably by not seeking legal advice about whether Noble could be required to deliver financial information?

 

The judge at 1^st instance did not find that the directors ought to have inquired into whether Apple Fields could compel Noble to deliver its financial information.  No legal advice was taken.

 

The judge in the 1st tier appeal held that the directors ought to have taken such advice, and having failed to do so they could not claim to have taken all reasonable and proper steps.

 

The Court of Appeal took a different view.  On the evidence, they said that there is no reason to suppose that Apple Fields could compel Noble to comply.  It does not control Noble in any orthodox sense.  The FMA was not able to identify any basis on which production might have been compelled.  The most its counsel could do was to suggest that the documentary record is incomplete and, that being so, there is a possibility that some right exists in the contracts between Apple Fields and Noble such that the directors have not discharged the burden of proof.

 

The Court of Appeal’s response is that in its opinion the evidence, such as it is, is that legal advice would have made no difference. That being so, it cannot be said that reasonable and proper steps required that legal advice be taken.

 

Outcome

 

Leave to appeal was granted.  A full (appeal) hearing is awaited – but the Court of Appeal appears to have nailed its colours to the mast on the reasonable reliance issue.

 

Further information

 

If you would like more information about any of the matters discussed in this note, please contact me.