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Doing business in Australia| Directors' duties

18 mins  26.09.2018

Each director of an Australian company owes duties to the company. At a basic level, those duties are designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company.

Overview

Each director of an Australian company owes duties to the company. At a basic level, those duties are designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company.

Directors are generally required to apply their particular skills and experience relevant to the matter being considered. If a director breaches their duties, they individually, as well as the company, could be subject to sanctions, including financial penalties and imprisonment.

This guide provides a general outline of the core and most relevant duties of directors of Australian companies under the Corporations Act. It does not detail or generally set out all duties owed by directors under common law or statute.

Common law duties

Directors are subject to a number of common law duties, including to:

  • act with care and diligence: to exercise their powers and discharge their duties with due care, skill and diligence;
  • act in good faith and for proper purpose: to act in the best interests of the company, and not for some private advantage or for any purpose for which the power was not granted;
  • not misuse information or position: not to improperly use or profit from their position or information obtained as a director to gain an advantage for themselves or someone else, or to cause detriment to the company;
  • avoid conflicts of interest or duty: to avoid conflicts between the director’s personal interests and the company’s interests, and between the director’s duties to the company and the director’s duties to anyone else; and
  • not fetter discretions: to give adequate consideration to matters for decision and to keep discretions unfettered.

These duties and their practical implications are considered further below.

There is a significant amount of case law on the scope and content of these duties and their application in different factual scenarios. Given its breadth, that case law is not explored in this guide.

Statutory law duties

The statutory duties of directors are contained in Part 2D.1 of the Corporations Act. These statutory duties apply in addition to the common law directors’ duties set out above, although the two sets of duties are broadly consistent. The Corporations Act may impose other, more specific obligations, in the context of a particular sector (for example, the duty imposed on a holder of an Australian Financial Services Licence).

The directors' statutory duties under the Corporations Act are set out below.

Duties of care and diligence

The Corporations Act requires a director to act with a degree of care and diligence that a reasonable person would exercise if he or she:

  • were a director in the company’s circumstances; and
  • had the same responsibilities as that director.

In determining the required standard of care, the court takes into account the company’s circumstances and the individual director’s responsibilities within the company.Whilst the scope of the duty depends on the circumstances, all directors are required to satisfy some core, non-delegable, minimum standards of care, skill and diligence, which include to:

  • become familiar with the fundamentals of the business and operations of the company;
  • keep informed and make appropriate inquiries about the company’s activities;
  • generally guide and monitor the company’s activities;
  • maintain familiarity with the financial status of the company (and to have the ability to read and understand financial statements and have a basic knowledge of accounting practice and material accounting standards);
  • have a reasonably informed opinion of the company’s financial capacity and solvency; and
  • carefully review, and apply their own minds to, any financial report and directors’ report the company is required to prepare under the Corporations Act (including by considering whether the information in the reports is consistent with their own knowledge or omits any material matters, and making appropriate inquiries if they are uncertain).

A director is also expected to attend board meetings unless exceptional circumstances (such as illness) prevent their attendance. Further, a director must be attentive at board meetings and cannot be excused from liability on the basis that he or she paid no attention to proceedings.

A director is entitled to delegate to others some responsibilities that would otherwise need to be performed by the director. However, the director is still responsible for adequate supervision, and for applying an inquiring mind and their own knowledge to the conduct of, and information provided by, the delegate. Wilfully ignoring the delegate’s performance will not be satisfactory. There are also some other responsibilities that cannot be delegated (eg final approval of accounts).

Duties of good faith and proper purpose

The Corporations Act requires a director to act:

  • in good faith in the best interests of the company; and
  • for a proper purpose.

What is meant by the ‘interests of the company’?

A director will breach this duty if they fail to give proper consideration to the separate interests of the company ahead of other interests. This is because the duty is generally owed to the company itself, not to individual shareholders or third parties.

Directors must take into account the interests of the company’s shareholders in order to satisfy the duty to act in the best interests of the company.

Where the only shareholder is its parent company it is, of course, appropriate for the directors to bear in mind the interests of that parent company. Under the Corporations Act, a director is taken to act in good faith in the best interests of a wholly owned subsidiary if the subsidiary’s constitution authorises the director to act in the best interests of the holding company, the director does so in good faith and the subsidiary is not insolvent.

Further, it is necessary for directors to have regard to the interests of creditors, particularly where the company is insolvent or nearing insolvency.

What is a ‘proper purpose’?

The powers of a director must be used for the purpose for which they were given, not a collateral purpose.

An improper purpose would include where the director uses a power to obtain advantage for themselves or someone else.

This is not an assessment of whether a business decision was a good or a bad decision. Rather, it is an assessment of how and why a particular power was used, and whether this is consistent with the purpose for which the power was given. For example, where directors issue new shares, was the share issue intended to raise money for the company or were the shares issued for a collateral purpose such as delivering control of the company to a particular person, ensuring that the directors remain on the board or obtaining some financial benefit for a director?

Duties not to misuse information or position

The Corporations Act requires that a director must not improperly use their position or information obtained because they are or have been a director, to:

  • gain an advantage for themselves or someone else; or
  • cause detriment to the company.

The statutory duties not to misuse information or position in practice mean that:

  • a director may not apply the company’s property either for the director’s personal benefit or for the benefit of any other person without the company’s authority (commonly requiring shareholder approval or constitutional authorisation); and
  • a director must not make unauthorised use of confidential information belonging to the company.

Being a director may bring various profitable business opportunities to one’s attention. Although directors may wish to take advantage of these opportunities, they must exercise care and might ultimately not be able to do so legally. Because of the obvious possibility of directors being attracted to business opportunities and the conflicts which may arise, the law curtails the freedom of directors to exploit those opportunities.

To ensure that directors comply with these requirements, the simple rule is to regard all corporate property, opportunities and information that has come into one’s possession as a director as belonging solely to the company and unavailable for the director’s use. Only if a director can demonstrate that the property or information does not belong to the company or is otherwise public, will the director be free to make use of it.

Other duties including the duty to prevent insolvent trading

Under the Corporations Act, there are other duties that impose specific obligations on directors. These include provisions prohibiting the falsification of records and the provision of false and misleading information.There is also a positive duty on directors to prevent the company from trading while insolvent.

A director breaches this obligation if he or she fails to prevent the company from incurring a debt at a time when:

  • the company is insolvent, or becomes insolvent by incurring that debt (or by incurring debts including that debt); and
  • the director is aware that there are grounds for suspecting that the company is (or would become) insolvent , or a reasonable person in a like position of the director would be so aware.

There are also specific provisions under which the director may become personally liable to the company (including at the instigation of a liquidator) or to a third party creditor for the amount of the debt and any loss or damage suffered by the creditor in relation to the debt because of the company’s insolvency.

There are certain defences a director may rely on, including that the director:

  • believed on reasonable grounds that the company was solvent;
  • relied on information from a competent and reliable person whom the director believed on reasonable grounds to be responsible for providing such information;
  • did not take part in the management of the company at the time because of illness or some other good reason; or
  • took all reasonable steps to prevent the company from incurring the debt.

In 2017, the Corporations Act was amended to provide directors with a defence to civil action for insolvent trading. Directors will be afforded an exception from liability for insolvent trading where the debt that the liquidator alleges had been incurred whilst the company was insolvent was incurred in connection with a course of action that is reasonably likely to provide a better outcome for the company than the immediate liquidation or administration.

Directors also have duties which are found in other legislation and which may impose significant personal liability on directors for a company's non-compliance (e.g. duties found in taxation laws, workplace health and safety laws, financial services legislation, environmental legislation and trade practices regulations).

Consequences of breaching directors’ duties

Under Australian law, directors can be exposed to significant criminal and/or civil liabilities, or liability to pay compensation (damages), for a breach of their duties as a director. In addition, any alleged breach of directors' duties could have a significant impact on a director's and company's reputation.

The specific consequences of breach and available remedies vary depending on the particular duty and the source of the duty (that is, whether contractual, equitable or statutory).

If directors breach any of the duties mentioned above or fail to meet any of their obligations they may have proceedings brought against them by:

  • the company;
  • shareholders under the statutory derivative action provisions (provided the court in its discretion grants leave to the applicant);
  • regulators such as ASIC or the ACCC;
  • third parties for misleading and deceptive conduct or anti-competitive behaviour; and
  • creditors and insolvency administrators in the context of insolvent trading.

Directors can be exposed to criminal liability in relation to a breach of certain statutory duties if the breach is committed with intentitonal dishonesty.

The Australian government has recently indicated an intention to increase the maximum penalties to 10 years' imprisonment and/or the larger of A$945,000 or three times the benefit obtained by the director where an individual commits a serious criminal offence under the Corporations Act. The offences that are proposed to attract these inceased penalties include:

  • intentionally, recklessly or dishonestly contravening directors duties;
  • dishonestly failing to comply with finanical and audit obligations under the Corporations Act; and
  • knowingly or recklessly providing defective disclosure documents or statements under the Corporations Act.

The Corporations Act also gives the court power to disqualify a person from managing companies (which includes being a director) for a contravention of someprovisions in the Corporations Act.

Disclaimer

This publication presents a broad overview of the law at December 2018. It is intended as an introductory guide to doing business in Australia and answers preliminary questions frequently asked by those unfamiliar with the Australian business environment. Specific exceptions and factors that may be relevant to particular circumstances (including industry specific regulation) are not covered, and accordingly, this publication should not be considered as the provision of, or substitute for obtaining, legal advice.

As this is a summary only, it cannot be relied on for legal advice. It does not cover all of the different circumstances that might arise, nor does it seek to apply the law in any particular factual scenario. You should seek legal advice on specific factual scenarios.

For comprehensive and proper professional advice please contact MinterEllison.

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