A Guide to Directors’ Duties
Many people aspire to one day become a director of a company. The position of director allows you to significantly influence strategy and key decision-making. However, it’s important to understand that directors of Australian companies owe significant duties to their respective companies.
For sole director / shareholder companies, compliance with duties is generally straightforward (as there will be perfect alignment of interests). However, as a company grows its particularly important for directors to recognise the independent interests of the company (and through it, its shareholders, and in certain circumstances, its creditors and employees).
This guide will give you a brief overview of the key duties of directors, being:
· the duty of care and diligence,
· the duty to act in good faith in the best interests of the company,
· the duty to act for a proper purpose,
· the duty to avoid unauthorised conflicts and profits,
· the duty to disclose material personal interests,
· the duty to not misuse position and information, and
· the duty to prevent insolvent trading.
Who are the directors of your company?
When you first register a company you will need to advise ASIC of its director or directors. Each director should sign a consent to act as director and will require a director ID. The company then must keep ASIC updated of its directors as they change over time. Each of these persons is a formally appointed director of the relevant company.
Apart from directors who have been formally appointed, Australian law recognises de facto directors, who are persons who act like and exercise the control associated with a director, and shadow directors, who are persons whom the appointed directors of the company are accustomed to act under the direction of.[1]
Additionally, directors’ duties may in certain instances apply to officers of a company. Officers include company secretaries and persons who participate in decisions that affect a substantial part of the company’s business or are able to significantly influence the company’s financial standing.[2]
Thus, the directors’ duties have a wide reach, extending beyond formal appointments to any person who may hold significant control or influence within the company.
Duty of Care and Diligence
The duty of care and diligence applies to both directors and officers, requiring them to act with the care and diligence of a reasonable person in their position. This means that the standard of conduct a director is held to is dependent on the role that they have within the company as well as the specific characteristics of the company.
Standard of Care
The Courts have held that at a minimum, directors (and not other officers) are required to be familiar with and informed about the business of the company, be in a position to guide and monitor the management of the company, and be familiar with, and be able to understand, the financial statements of the company. This requires a regular review of financial statements.[3]
Beyond this minimum standard, the Courts will look to the substance of the director’s role, their experience and skill as well as how the company is structured (in terms of its constitution, distribution of work, size and nature etc.) to determine what a reasonable person in the director’s position would have done.[4]
Breach of the Duty
In determining whether this standard of care has been breached, the Courts engage in a balancing act between the foreseeable risks of harm of the director’s conduct against the potential benefits of the conduct.[5] This recognises the fact that directors are expected to take calculated risks and thus, not all risky actions will amount to breach of duty.
In ASIC v Kaur, a director was found to be in breach of his duty of care by deferring all affairs of the company to his wife, another director, who used investor monies for personal purposes. This case demonstrates the need for a director to be involved in the management of the company and to monitor and supervise their fellow directors.[6] A director cannot rely on delegating their duties wholesale to other directors.
Defences to a Breach
Even if a director does not act in the way a reasonable director would, they may not be in breach of their duty if one of the following defences apply.
· If a breach arises in circumstances where the director has delegated power, the director will not be liable if the director reasonably believed that the delegate was reliable and competent and would act in conformity with the directors’ duties, and the director monitors the delegation.[7]
· If a breach arises because the director relies on a third party, the director may not be liable if the person relied upon was competent or a professional adviser in relation to the information and the director’s reliance was made in good faith after an independent assessment of the information.[8]
· If the director made the judgment in good faith for a proper purpose, does not have a material personal interest in the matter, informed themselves about the matter and rationally believed that their judgment was in the best interests of the company.[9]
Duty to Act in Good Faith
The duty to act in good faith and for a proper purpose requires directors and officers to act with a bona fide belief that their actions are in the best interests of the company.[10] Therefore, the Courts will look at what the director’s subjective purposes and beliefs were in order to determine if they have breached the duty to act in good faith. However, if the decision that was made was one that no reasonable director would think was in the best interests of the company, the duty will have been breached.[11]
What are the best interests of the company?
Generally, ‘best interests of the company’ is interpreted as the collective interests of the company’s shareholders.[12]
For example, in GJB Building Pty Ltd v AI&PB Property Pty Ltd, a director who authorised payments in a manner inconsistent with the company’s shareholders agreement and internal governance rules was found to have breached the duty to act in good faith in the best interests of the company.[13]
However, the interests of creditors and employees may also be relevant in determining whether the director or officer has acted in the best interests of the company, particularly where the company may be verging on insolvency.[14]
Duty to Act for a Proper Purpose
Under this duty, the Court will look at the company’s constitution and circumstances to determine the permissible purposes. The duty to act for a proper purpose bears similarity to the duty to act in good faith but has been established as a separate duty under the Corporations Act.
This duty will be breached where the director’s substantial purpose was improper, that is outside of the permissible purposes that they can act for.[15]
In GJB Building Pty Ltd v AI&PB Property Pty Ltd, authorising payments to third parties that included personal creditors of the directors were, not unsurprisingly, held to be improper purpose.[16]
Duty to Avoid Unauthorised Conflicts and Profits
The duty to avoid unauthorised conflicts and profits is not covered by the Corporations Act but arises in equity as a fiduciary obligation.
This duty will be breached if, where a conflict exists, a director pursues personal interest.[17] This requires directors to engage in conduct to avoid such a conflict, such as disclosing the interest, but the exact requirements of the duty are dependent on circumstances such as the subject matter of the conflict, the director’s involvement in a decision and the possible consequences.[18]
In Australian Careers Institute v Australia Institute of Fitness, a director of AIF and ACI, who was also a shareholder of both, was in breach of this duty by promoting and helping a subsidiary of ACI that was a competitor of AIF. Of note in this case was the fact that the Court considered this conduct as the director advancing his personal interests in a secretive manner.[19]
In addition to the duty to avoid conflicts, directors cannot obtain a benefit where a conflict exists or through any opportunity or knowledge that arises from their position.[20] A benefit includes the deprival of an opportunity that rightly belongs to the company.[21] Where a conflict exists, a director can generally only retain a profit where they have disclosed their interest and the transaction is approved by a general meeting.[22]
Duty to Disclose Material Personal Interests
The Corporations Act complements the duty to avoid conflicts by requiring that directors give other directors of the company notice of any material personal interest in the affairs of the company.
The Courts have suggested that the director’s interest will be ‘material’ if it has the capacity to influence the vote or decision-making of a director.[23]
Duty to not Misuse Position and Information
The Corporations Act also includes provisions to complement the duty to avoid unauthorised profits. These provisions also extend to officers and employees of a company, in which they must not improperly misuse their position, or information obtained through their position, to gain an advantage for themselves or someone else, or cause detriment to the company.[24]
Duty to Prevent Insolvent Trading
A director will be in breach of the duty to prevent insolvent trading if the following are satisfied:
· the director was a director at the time the company incurred a debt;
· when the company incurred that debt, the company was or became insolvent;
· there were reasonable grounds to suspect that the company was insolvent or would become insolvent; and
· the director was aware of those grounds or a reasonable person in the director’s position would have been aware of those grounds.[25]
Under this duty, the meaning of debt extends to transactions such as paying dividends, reducing share capital and share buy-backs.[26]
The Corporations Act defines ‘insolvent’ as a person who is not ‘solvent’ being a person who is able to pay its debts as and when they become due and payable.[27] This involves an assessment of a company’s liquidity, that is, whether their anticipated current and future cashflows are sufficient to pay its liabilities as they fall due.[28]
Determining whether there were reasonable grounds to suspect that the company was insolvent or would become insolvent is an objective analysis of the circumstances when the debt was incurred and whether it suggests something more than a mere possibility of insolvency.[29]
If the above is established, then a director will be in breach of the duty in one of two circumstances. Firstly, if they were subjectively aware of facts that cause reasonably competent director to suspect that the company was insolvent.[30] Secondly, if objectively, a reasonable person in the director’s position would be aware that there were grounds for suspecting that the company was insolvent.[31]
However, a defence against a breach of the duty will apply if one of the following applies:
· If the director had reasonable grounds to expect, and did in fact expect, that the company was solvent and would remain solvent.[32]
· If the director had an expectation that the company was solvent or would remain solvent on the basis of information provided by a competent and reliable person.[33]
· If the director did not participate in the management of the company at the time due to illness or some other good reason.[34]
· If the director took all reasonable steps to prevent the company from incurring the debt.[35]
· If the director started to develop a course of action that was reasonably likely to lead to a better outcome for the company.[36]
Consequences of breaching a directors’ duty
Breach of the directors’ duties under the Corporations Act will may in civil penalties and potentially disqualification from management of companies. Further, where a director dishonestly or recklessly breaches one or more of the duties to act in good faith, for a proper purpose, and to not misuse position or information, then that director may be criminally liable as well.[37]
Summary
The common thread through the various duties is that directors should be acting for the benefit of their company, rather than self interest or the interest of third parties, in a transparent manner.
Additionally, directors and officers should consider risks in light of commercial strategy based on an informed position and that align with what a reasonable person in their position would do.
This article was written by Pippin Barry, BA JD (Unimelb), an Australian Lawyer, and Kai Chue, BComm (Unimelb), paralegal.
[1] Corporations Act 2001 (Cth) s 9AC(1).
[2] Corporations Act 2001 (Cth) s 9AD(1).
[3] Daniels v Anderson [1995] 37 NSWLR 438.
[4] ASIC v Rich [2003] NSWSC 85; ASIC v Maxwell [2006] NSWSC 1052.
[5] Cassimatis v ASIC [2020] FCAFC 52.
[6] ASIC v Kaur [2023] FCA 599.
[7] Corporations Act 2001 (Cth) s 190(2).
[8] Corporations Act 2001 (Cth) s 189.
[9] Corporations Act 2001 (Cth) s 180(2).
[10] Re Smith & Fawcett Ltd [1942] Ch 304.
[11] Bell Group Ltd v Westpac Banking Corp (No 9) [2008] WASC 239.
[12] Bell Group Ltd v Westpac Banking Corp (No 9) [2008] WASC 239.
[13] GJB Building Pty Ltd v AI&PB Property Pty Ltd [2023] VSC 782.
[14] Parke v Daily News Ltd [1962] Ch 927.
[15] Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.
[16] GJB Building Pty Ltd v AI&PB Property Pty Ltd [2023] VSC 782.
[17] Fitzsimmons v R (1997) 23 ACSR 355.
[18] Fitzsimmons v R (1997) 23 ACSR 355.
[19] Australian Careers Institute v Australia Institute of Fitness [2016] NSWCA 347.
[20] Chan v Zacharia (1984) 154 CLR 178.
[21] Cook v Deeks [1916] 1 AC 554
[22] Furs Ltd v Tomkies (1936) 54 CLR 583.
[23] McGellin v Mount King Mining NL (1998) 144 FLR 288.
[24] Corporations Act 2001 (Cth) ss 182–183.
[25] Corporations Act 2001 (Cth) ss 588G(1)–(2).
[26] Corporations Act 2001 (Cth) s 588G(1A).
[27] Corporations Act 2001 (Cth) ss 95A(1)–(2).
[28] ASIC Regulatory Guide 217.
[29] Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266; Hall v Poolman [2007] NSWSC 1330.
[30] Corporations Act 2001 (Cth) s 588G(2)(a); ASIC v Plymin (No 1) (2003) 175 FLR 124.
[31] Corporations Act 2001 (Cth) s 588G(2)(b).
[32] Corporations Act 2001 (Cth) s 588H(2).
[33] Corporations Act 2001 (Cth) s 588H(3).
[34] Corporations Act 2001 (Cth) s 588H(4).
[35] Corporations Act 2001 (Cth) s 588H(5).
[36] Corporations Act 2001 (Cth) s 588GA(1)(a).
[37] Corporations Act 2001 (Cth) s 184.
