ACC8801 Corporate Governance - James Hardie: Restructuring, removing and reviewing the social contract - Case Study Assessment Answers

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(Source: Lisa Barnes, University of Newcastle)

On Thursday 15 February 2007, the Australian Securities and Investments Commission (ASIC) commenced civil penalty proceedings relating to James Hardie. Both current and former directors and executives were investigated on matters of possible criminal issues, especially in relation to the Medical Research and Compensation Foundation (MRCF). On Friday 16 February, the then Chair of James Hardie, Meredith Hellicar, and several directors resigned their positions.

History of James Hardie

James Hardie was founded in the late nineteenth century, and became an iconic company, especially in Australia in the twentieth century, for mining, importing and manufacturing asbestos-based products. Commonly referred to as ‘fibro’, fibro-cement played a key role in the growth of expanding cities as it was a cheaper alternative to brick, but supposedly safe and durable. However, fibro sold by James Hardie was made of asbestos, which even back in the 1930s was known to be ‘causing deadly lung disease’ (Ministry of Health Report 1938, cited in Kjellstrom 2004). Indeed, for James Hardie, the first workers’ compensation case occurred in 1939 (Hills, 2005); but it was not until the mid-1960s that James Hardie was given information on asbestos-related diseases among its employees in which they were told that liabilities could be as high as A$1.5 million, which set against shareholders’ funds of $30 million seemed significant (Haigh, 2006). Despite these health warnings and potential impact of liabilities from compensation, James Hardie continued to manufacture the product until 1987.

Asbestos and its health impacts

Asbestos has been found to cause many medical conditions including lung disease and, in particular, mesothelioma, lung cancer and asbestosis. Mostly, however, it takes between 15 to 30 years before symptoms present themselves after people are exposed to asbestos dust (Smartt, 2004). Asbestos was mainly used in domestic and industrial buildings, brake linings, fibro sheeting, pipes and insulation. The health effects of its use are not limited to employees, however; they also include neighbours of mines and manufacturing plants, and demolition contractors. These effects are recognized internationally (Jackson, 2004).

The fact that the medical implications of exposure to asbestos were known as early as the late 1930s, and that James Hardie knew about it via their own employees’ workers compensation claims in the 60s, and the fact that it took another 20 years until the manufacture of asbestos products ceased, showed that manufacturers ‘knew at an early stage about the dangers of asbestos and made a commercial decision to keep producing it, thereby jeopardizing lives’ (Spender, 2003: 235).

The Medical Research Compensation Foundation (MRCF) and restructure

In early 2001, the board of James Hardie made several announcements, one of which was the establishment of the MRCF. This fund was to ‘compensate sufferers of asbestos related diseases and claims against two former James Hardie subsidiaries and fund medical research aimed at finding cures for these diseases’ (JHIL, 2001). The fund was established to effectively resolve any liability in relation to asbestos, which would then allow the board to concentrate on growing the company ‘for the benefit of all shareholders’ (JHIL, 2001). The foundation was supposed to have sufficient funds (A$293 million) to cover all legitimate past and future claims; the funding was by way of ownership of subsidiaries Amaca and Amaba which had net assets of $293 million, and James Hardie also stated that any leftover funds would be used to support further research on lung disease (JHIL, 2001).

Later in 2001, a new holding company was set up, called James Hardie Industries NV (JHI NV), and the group moved to the Netherlands where Australia has no civil law enforcement agreements. The decision to restructure and relocate was granted by the Supreme Court of New South Wales, based on the assurance by the company that any future claims would be met and backed up by partially paid shares in JHIL held by JHI NV. However, these shares were subsequently cancelled when JHIL (later known as ABN 60 Pty Ltd) vested in a new company, the ABN 60 Foundation, which was still supposedly able to meet any obligations for the MRCF. The complex structures and restructure of James Hardie made it harder to guarantee the liability of claims would be met.

The MRCF, however, had been substantially underfunded. A report by KPMG re-estimated the liabilities to be A$693 million, rising to $1044 million in 2000 (Haigh, 2006). The shortfall caused much activity by lobby groups such as trade unions and local councils, resulting in the 2004 Jackson Inquiry. The findings indicated that James Hardie had acted within the law; however, it also discovered that James Hardie did not use reliable actuarial estimates, the company had made misleading public statements and appeared to be deliberately avoiding its moral obligations to society (Tozer and Hamilton 2006).

The future for James Hardie and its victims

James Hardie agreed that the MRCF was underfunded. In 2005, James Hardie signed a Final Funding Agreement (FFA) with the NSW state government, where claims were re-estimated to be A$4.5 billion over 40 years (Slater and Gordon, 2005). Negotiations then began with the Australian Taxation Office to set up a charitable organisation to fund the rest of the expected liabilities related to asbestos exposure. The arrangement established the Asbestos Injuries Compensation Fund Limited (AICFL), which would receive income annually from James Hardie according to a formula based on a percentage of ‘free cash flow’ and a ‘cap percentage’.

The arrangement was agreed to by shareholders in early February 2007 as it ‘is consistent with current investor and Australian Community expectations’ (JHI NV, 2007). Little did James Hardie know that one week later, ASIC would commence proceedings into the actions of former and current directors and executives, alleging breaches of the Corporations Act 2001. The five allegations were:

1. Misleading communications in 2001 regarding the establishment of the MRCF.
2. Failure to disclose in relation to Deed of Covenants between MRFC and JHIL.
3. Restructure of the group: The scheme of arrangement, specifically the information memorandum, was misleading in terms of its lack of disclosure in relation to the meeting of future obligations.
4. Misleading executive presentations: in 2002, presentations made to institutional investors contained information on the supposed adequacy of the MRCF in meeting its obligations in relation to asbestos liabilities.
5. Failure of care and diligence: in relation to the cancellation of shares in JHIL, and the failure of information disclosed to ASX and ASIC in relation to the cancellation.

Currently, according to ASIC (2007) ‘the investigation, which continues, has involved a complex corporate structure, it has spanned three countries (the US, the UK and Australia) and it has involved about 348 documents, 72 examinations and the issuing of 284 notices to obtain evidence’. The investigating continues as does the increase in the number of victims being identified and claims sought. It appears that the profit motive was prioritised by James Hardie at the expense of the social contract.

Identify the various stakeholders of James Hardie and list next to each stakeholder group what corporate governance responsibilities are owed by its board of directors and senior management to each stakeholder group. It is possible that some corporate governance responsibilities are owed to more than one stakeholder group. Where this occurs (in your opinion), you should combine the relevant stakeholder groups into the identification of the specific corporate governance responsibility(ies).

Q2 Outline the key corporate governance issues in the James Hardie case, by referring to the ASX corporate governance principles and recommendations (2007) that should have been applicable to James Hardie if the company had not re-structured their organisation offshore.

Q3 Give examples of actions that the company could have taken in order to comply with the ASX guidelines that you have identified as being applicable above in your answer for Q2, and provide your reasoning for selecting these actions (15 marks)

Q4 How were the long term interests of each of these stakeholder groups affected or exacerbated by James Hardie directors’ decision to continue to manufacture the asbestos based product from mid-1960s until 1987?

Q5 Comment on the decision made by the board of director in mid-1960s. Was it legal at that time (i.e., mid-1960s)? Was this ethical decision making at that time (i.e., mid-1960s)? Include in your answer a discussion that demonstrates the difference between business ethics and moral ethics. Provide a reasoned argument to support your answer.

Q6 How did the actions of various stakeholders potentially threaten James Hardie's ability to achieve corporate sustainability?