Law reform in New Zealand: creeping criminalisation?
July 2015 | SPECIAL REPORT: WHITE-COLLAR CRIME
Financier Worldwide Magazine
A number of domestic and international events in the past decade have precipitated reviews of legislation regulating the conduct of business in New Zealand. There have been notable moves toward the criminalisation of the conduct of directors and officers, particularly in the area of directors’ duties, cartels and health and safety. At the same time, there has been a move away from ‘strict liability’ criminal offences for directors of issuers of securities, in favour of more flexible civil remedies.
Criminalisation of breaches of directors’ duties
The global financial crisis saw the failure of more than 60 finance companies in New Zealand. The perception that the public had lost confidence in financial markets prompted the government to institute a comprehensive programme of reforms in the financial sector. One such reform was the criminalisation of breaches of certain directors’ duties. While it has long been the case that directors can be held liable as parties to many offences committed by a company, the legislature sought to implement criminal sanctions which would capture behaviour relating explicitly to breaches by directors of their duties to a company.
The Companies Act 1993 was based on a small firm model, and private, rather than public, enforcement was assumed. Directors’ duties are owed to the company and, except for cases in which a derivative action could be brought by a shareholder, or claims by a liquidator following the company’s liquidation, only the company was able to enforce them prior to the reforms. In the wake of the global financial crisis there was a perception that breaches of directors’ duties were under-enforced, the decision to litigate was a management decision and rested in the hands of company directors, including the breaching directors. There was little incentive for a minority shareholder to bring a derivative action as any compensation would be paid to the company, and regulators lacked the ability to enforce directors’ duties.
The Companies Act was amended in 2014 to include two new offences for breaching core directors’ duties: the duty to act in good faith towards the company, and the duty not to engage in reckless trading (causing or allowing the business of the company to be carried out in a manner likely to create a substantial risk of serious loss to the company’s creditors). The first created an offence in circumstances where a director acts in bad faith towards the company, believing that the conduct was not in the best interests of the company, and knowing that the conduct will cause serious loss to the company. The second created an offence where a director allows the company to incur a debt when it is insolvent, or where the debt will render the company insolvent, knowing of the insolvency and dishonestly failing to prevent the company from incurring the debt. Deliberate conduct is required as an element of each offence. The penalty for commission of either offence is imprisonment for a term of up to five years or a fine not exceeding NZ$200,000.
The move to criminalise directors’ duties gave rise to considerable controversy within the legal profession when it was initially proposed. Concerns were raised that the threat of criminal sanctions might make it more difficult to attract high quality directors, and that directors would be hesitant to take legitimate business risks for fear that judges, in hindsight, would review their decisions negatively. There was also concern that the contours of what was required of directors in performing their duties was insufficiently clear to make it fair to impose criminal penalties, including imprisonment, for their breach. The offences were ultimately tempered and the conduct that is now criminalised is relatively tightly defined. To date there do not appear to have been any prosecutions of directors for these new offences, and it may be too early to judge their effect on corporate governance in New Zealand.
Criminalisation of hard-core cartel conduct
The government is also currently in the process of introducing some of the most significant amendments to New Zealand’s competition legislation, the Commerce Act, since it was passed in 1986 through the enactment of the Commerce (Cartels and Other Matters) Amendment Bill. The bill is expected to be enacted during 2015.
The bill contains two notable changes to competition law in New Zealand. First, the bill proposes to replace the current prohibition on price fixing between competitors with an expanded prohibition on ‘cartel conduct’, which will include not only price fixing but also output restriction and market allocation agreements between competitors. Significantly, the bill will make engaging in cartel conduct a criminal offence, with individuals found guilty liable for imprisonment for up to seven years. The penalties for companies will remain the same: liability for fines of up to $10m, three times the commercial gain resulting from the activity or 10 percent of the entity’s turnover for each accounting period in which the activity occurred.
Second, the bill introduces a number of new exemptions from the cartel prohibition for certain conduct, notwithstanding that it technically falls within the definition of ‘cartel provision’. In addition to the existing exemption for joint buying arrangements, the bill will introduce new exemptions for cartel provisions in ‘vertical supply contracts’ and cartel provisions in ‘collaborative activities’ (i.e., ongoing joint commercial activities) provided that the provision does not have the dominant purpose of lessening competition between the parties and, in the case of the collaborative activities exemption, the cartel provision is ‘reasonably necessary’ for that collaborative activity (this exemption replaces the current defence available to joint venturers). The bill will also provide a defence to a criminal (but not civil) prosecution where a defendant is involved in a ‘collaborative activity’ and ‘honestly believes’ the cartel provision was reasonably necessary for the purpose of the collaborative activity.
As noted above, these provisions are not yet part of New Zealand law; the bill has been delayed a number of times since its introduction in 2011.
Increasing penalties for breaches of health and safety requirements
Following an investigation into a serious coal mining accident at the Pike River Mine, which highlighted several issues with New Zealand’s workplace health and safety system, the government convened an independent taskforce to investigate strategies for reducing the incidence of workplace harm by at least 25 percent by 2020. The recommendations of that taskforce were adopted, and the Health and Safety Reform Bill was introduced in March 2014.
This bill proposes to create new duties owed by officers and directors to ensure, and the circumstances in which officers and directors will be held liable for the failure of a company to ensure, the health and safety of persons in workplaces. The bill proposes to provide for due diligence duties on the part of directors and officers to make sure they are informed regarding health and safety matters, rather than leaving compliance solely with management. It also proposes to create three tiers of offences for breaching those duties. The most serious offence will apply in the case of reckless breach (i.e., recklessly exposing an individual to the risk of death or serious injury), for which the bill provides for a penalty of imprisonment for up to five years and/or a fine of $600,000 for a director or officer of a company, and a fine of up to $3m for the company. In the case of breach of a duty (i.e., breach of a duty which exposes an individual to risk of death or serious injury), the bill creates a strict liability offence, for which an officer or director may be fined $300,000 and a company $1.5m. In the case of a breach of duty (which does not require that an individual be exposed to the risk of death or serious injury), a director or officer may be liable for a fine of $100,000 and a company a fine of $500,000. In the case of reckless breach, the penalties represent a six-fold increase on the penalties contained in the current health and safety legislation.
Significant reform of securities law
While there is a move to criminalising directors’ conduct in some areas, the Financial Markets Conduct Act 2013 represented a swing away from criminalisation, moving instead towards civil liability and penalties for the conduct of directors and officers.
The act replaced the former Securities Act 1978 (which regulated primary markets) and the Securities Markets Act 1988 (which regulated secondary markets). The liability regimes in those acts had been criticised as lacking coherence and being difficult to apply in practice. Notably, the Securities Act provided for a strict liability offence (with limited available defences) for distributing an advertisement or registering a prospectus containing an untrue statement. Following the prosecution of the directors of one failed finance company for breaching that provision, New Zealand’s Supreme Court described the culpability of the directors as “comparatively limited”, characterising them as “honest men who took their responsibilities seriously” but who were merely guilty of “misjudgement” in committing the offence (Graham v R  NZSC 55).
The new legislation focuses instead on civil liability (including civil pecuniary penalties) to punish breaches. It provides a comprehensive range of penalties, including an infringement notice regime for minor compliance contraventions, civil liability (and penalties) where appropriate, and criminal offences only for the most serious and deliberate violations. In the limited circumstances in which criminal sanctions are available, the conduct in question must have been engaged in with knowledge or recklessness. For the majority of breaches, civil liability will be imposed instead.
When viewed collectively, the recent reforms indicate a greater willingness on the part of the New Zealand legislature to criminally sanction blameworthy conduct on the part of company directors and officers. However, where the government perceives some other regime to be a more effective and tailored approach, such as civil liability for violations of the new financial markets laws, that approach has been preferred. The reforms have arguably brought a greater tailoring of penalties to the types of conduct sought to be deterred and punished – namely, wrongful conduct, which is engaged in deliberately or recklessly by company directors and officers. The more targeted approach of the criminal sanctions contained in the reforms described above may mitigate the potential for overreach by regulators, and provide greater certainty as to what conduct is captured by each offence.
Further, the criminalisation of corporate conduct brings New Zealand into closer line with other, similar, jurisdictions (in particular Australia and the US) where certain types of corporate conduct have been the subject of criminalisation for some time. This may assist with cross-border enforcement, as similar conduct is now the subject of similar enforcement and penalty provisions in each jurisdiction.
Polly Pope is a partner and Vicki McCall is a senior solicitor at Russell McVeagh. Ms Pope can be contacted on +64 9 367 8844 or by email: firstname.lastname@example.org. Ms McCall can be contacted on +64 9 367 8386 or by email: email@example.com.
© Financier Worldwide
Polly Pope and Vicki McCall