DIRECTORS’ & OFFICERS’ DUTIES

THIS SUMMARY PROVIDES AN OVERVIEW OF THE OBLIGATIONS OF DIRECTORS OF UNLISTED AUSTRALIAN COMPANIES.

DEFINITIONS USED IN THIS SUMMARY

This summary contains general information only and is not legal advice. Please contact us if you require specific legal advice on any of the following matters.

In this summary, all references to ‘the Act’ are to the Corporations Act 2001 (Cth).

OUTLINE OF THIS SUMMARY

This summary consists of the following parts:

■ Part A - Directors’ obligations at general law. ■ Part B - Directors’ (and other officers’) obligations

under the Act. ■ Part C - Consequences of a breach of duties under the

Act. ■ Part D - Other key risks for directors. ■ Part E - Protection for directors.

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PART A: DIRECTORS’ OBLIGATIONS AT GENERAL LAW

Overview of key fiduciary duties

A director of a company owes fiduciary duties to the company at common law, which are essentially to exercise care and diligence in the performance of their functions. In particular, a director must:

■ Act in good faith and in the best interests of the company. ‘Good faith’ contains both subjective and objective elements, in that a director must genuinely believe that he or she is acting in the company’s best interests and must also act in a way that an honest and reasonable director would act.

■ Exercise his or her powers for a proper purpose. In determining what is a proper purpose, the purpose motivating the exercise of the power must accord with the objective purpose for which the power was granted.

■ Not fetter his or her own future discretion. Directors must exercise active discretions and not improperly limit their decision-making authority. This does not prevent directors from delegating powers to others, provided such a decision is made with authority and is entered in the minutes of the company. Delegation is discussed further below.

■ Avoid conflicts of interest and duty. If a director must choose between favouring his or her own interests and the interests of the company, the director must usually choose the latter course. A director should attempt to avoid situations that have the appearance of a conflict of interest.

In addition, a director’s other fiduciary duties require that the director must:

■ Not apply the company’s property for his or her personal benefit or for anyone else’s benefit without the company’s authorisation.

■ Account to the company for any profit that he or she makes in connection with his or her office without the company’s fully informed consent.

■ Not exploit or divert from the company a business opportunity falling within the company’s current or prospective line of business.

Other common law duties

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

■ A duty to exercise care, skill and diligence under both the common law tort of negligence and the equitable duty of care.

■ A duty to act lawfully. ■ A duty not to prejudice creditors’ interests if the

company is insolvent.

Who can bring an action against directors for a breach of fiduciary duty?

If a director breaches a fiduciary duty and the company consequently suffers a loss, the company will be able to bring a legal action for damages or compensation.

The Australian Securities and Investments Commission (ASIC) can also recover damages or property from directors who breach their duties or engage in misconduct.

An individual director or shareholder of the company could also bring proceedings in certain circumstances.

What remedies could be sought for a breach of a director’s fiduciary duties?

A number of remedies may be available to a company in response to a breach of a fiduciary duty by one or more of its directors. These include:

■ Grant of an injunction. ■ Action for damages or compensation. ■ Entitlement to profits made by the director. ■ An order that property held by a director be held on

trust for the company. ■ Rescission of a contract entered into by a director

improperly.

Can shareholders ever relax these duties, or ratify or exonerate a breach of duty?

A company’s shareholders (or ‘members’) can ratify and relax certain duties owed by directors by passing a resolution at a general meeting, in effect authorising what would otherwise be a breach, or forgiving an existing breach. Any such consent by the members must be fully informed consent.

PART B: DIRECTORS’ (AND OTHER OFFICERS’) OBLIGATIONS UNDER THE ACT

‘Officers’ under the Act

The common law duties are supplemented by the duties imposed under the Act on a company’s ‘officers’, directors, secretaries and/or employees.

The term ‘officer’ is defined extremely broadly in section 9 of the Act and includes directors, any company secretary or secretaries, a person who makes or participates in making decisions that affect the whole or a substantial part of the company’s business, a person who has the capacity to affect significantly the company’s financial standing, a person in accordance with whose instructions or wishes the directors of the company are accustomed to act and certain other persons.

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Key duties imposed under the Act

In summary, under the Act a director or other officer of the company will be required to:

■ Act with care and diligence. ■ Act in good faith, in the best interests of the company

and for a proper purpose. ■ Not use his or her position to gain advantage for

himself or herself or others or cause detriment to the company.

■ Not use information to gain advantage for himself or herself or others or cause detriment to the company. This duty will continue to apply after a director ceases to be a director of the company.

Directors and other officers who breach these duties are liable for civil and, in some circumstances, criminal penalties.

In general terms, a director’s duty of care and diligence obliges directors to have a basic understanding of the company. Directors should also keep informed of the company’s activities and its financial status.

The Act also imposes a number of other duties on directors, including:

■ A duty to disclose to fellow directors any material personal interest in matters that relate to the affairs of the company (which is discussed further below).

■ A duty to prevent insolvent trading by the company.

Other procedural and disclosure requirements

The Act specifies certain procedures that directors must follow, including procedures for calling and holding meetings of members and board meetings.

The Act also obliges directors to disclose certain remuneration and other benefits they receive.

Financial records and accounts

The Act requires every company to keep written financial records that:

■ Correctly record and explain the company’s transactions and financial position and performance.

■ Would enable true and fair financial statements to be prepared and audited.

Failure to comply with these requirements is a strict liability offence and can result in criminal penalties applying.

The company will also be obliged under the Act to prepare a number of reports each financial year, including a financial report and directors’ report. Directors should obtain appropriate professional assistance in preparing these documents to ensure compliance with the Act.

Duty to prevent insolvent trading

Under section 588G of the Act, a director (or the directors jointly) can be held personally liable for the company’s debts if they allow the company to trade whilst it is insolvent or its insolvency would have been objectively suspected.

Insolvent trading will occur if the company incurs a debt whilst it is insolvent, or becomes insolvent by incurring a debt. There are a limited number of defences to this form of liability. A defence will be available to a director who can prove that he or she took all reasonable steps to prevent the company from incurring the debt. A director will also have a defence if:

■ The director had reasonable grounds to expect, and in fact did expect, that the company was solvent and would remain solvent even if it incurred the debts it incurred at the time.

■ The director received adequate information as to solvency of the company from a competent and reliable person who was fulfilling a responsibility to provide such information, had reason to believe that person and in fact did believe that the company was solvent and would remain solvent even if the debt was incurred.

■ If at the time the company was trading while insolvent, the director, because of illness or some other good reason, was not taking part in the management of the company.

■ If at the time the company was trading whilst insolvent, the director acted honestly and reasonably in the circumstances.

Accordingly, directors should:

■ Take great care in monitoring the company’s financial position at all times.

■ Seek appropriate professional assistance sooner rather than later if there are concerns about the company’s solvency.

Special duties imposed on company secretary

The company secretary is typically responsible for recordkeeping (eg maintenance of the registers required by the Act) and preparation and keeping of minutes of meetings of directors and members, among other administrative matters.

Section 188 of the Act imposes specific duties on the company secretary, which broadly speaking relate to administrative matters (such as ensuring that the company maintains a registered office and lodges certain documents with ASIC). The secretary must take all reasonable steps to ensure that the company complies with those requirements. If the company does not have a secretary, the directors will be responsible for these matters.

Finally, as an ‘officer’ of the company the secretary will also be subject to the relevant duties outlined above.

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Disclosure of material personal interests

Under section 191 of the Act, a director must disclose any material personal interest that he or she has in a matter that relates to the affairs of the company. Failure to do so may result in the director being subject to civil penalties under the Act.

A director should disclose any material personal interests that he or she may have to the board at the first board meeting. The term ‘material personal interest’ is not defined in the Act, however, case law indicates that the interest must be personal, of some substance or value and must have a realistic capacity or propensity to influence the director’s decisions in administering the company’s affairs.

Generally speaking, it is advisable to assume that an interest is material and accordingly provide full disclosure. In addition, it can be prudent in all the circumstances to fully disclose personal interests even if disclosure may not be required by law.

PART C: CONSEQUENCES OF A BREACH OF DUTIES UNDER THE ACT

Key penalties for breach of duty

The penalties for a breach of the provisions of the Act can be severe. A director or other officer who fails to perform his or her duties may:

■ Be guilty of a criminal offence with a penalty of up to $220,000 or imprisonment for up to five years or both.

■ Be ordered to pay the Commonwealth a penalty of up to $200,000.

■ Be personally liable to compensate the company or others for any loss or damage they suffer.

■ Be prohibited from managing a company.Such proceedings are taken by ASIC.

PART D: OTHER KEY RISKS FOR DIRECTORS

Personal liability for the company’s debts

Directors can be held personally liable for debts of the company in a number of circumstances, including:

■ If they permit the company to engage in insolvent trading. ■ If they participate in management whilst disqualified. ■ If the company fails to pay employment debts (eg

employee entitlements) and is insolvent. ■ If the company is insolvent and tax remains payable to

the Commissioner of Taxation. ■ If the company has failed to remit employee tax

deductions to the ATO. ■ If the company incurs a liability while acting or

purporting to act as a trustee and is subsequently unable to discharge the liability or seek indemnity from the assets of the trust.

Contravention through involvement

It is important to note that ‘involvement’ in a contravention of the Act is also deemed to be a contravention. ‘Involvement’ includes:

■ Aiding, abetting, counselling or procuring the contravention.

■ Inducing the contravention. ■ Being in any way, by act or omission, knowingly

concerned in or party to the contravention. ■ Conspiring with others to effect the contravention.

For example, if the company was to commit a breach of the Act, one or more directors may be held to have been ‘involved’ in that contravention and so contravened the Act themselves.

Director’s reliance on information or advice from others

It is accepted that directors will sometimes base their decisions on the information or advice provided by others. However, the Act only permits such reliance if it is reasonable.

A director’s reliance will be reasonable where the director relies on advice given or prepared by an employee or professional adviser (whom the director believes on reasonable grounds to be reliable), or the advice of another director or a committee of directors, provided the reliance is made in good faith and after making an independent assessment of the information or advice, having regard to the director’s knowledge of the company and the complexity of the structure and operations of the company.

If these requirements are not met, directors who accept advice or information provided by others in the process of decision making may nonetheless be responsible for the consequences flowing from their decisions, even if that information or advice was incorrect, misleading or incomplete.

Delegation of a director’s power

A director can delegate a power to any person if such delegation is recorded in the company’s minutes and provided delegation is exercised in accordance with the powers of the director. However, a director will remain responsible for how that delegated power is exercised unless the director believed:

■ On reasonable grounds, at all times, that the delegate would exercise the power in conformity with the law and the company’s Constitution.

■ On reasonable grounds in good faith and after making proper inquiry, if the circumstances indicated the need for inquiry, that the delegate was reliable and competent in relation to the power delegated.

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Duties imposed on directors by other legislation

Personal liability can also be imposed on directors and senior management under a range of other statutes, including:

■ The Competition and Consumer Act 2010 (Cth). ■ Anti-discrimination legislation. ■ Occupational health and safety legislation. ■ Environmental legislation.

PART E: PROTECTION FOR DIRECTORS

Rights of directors

Directors have a number of legal rights to assist them in performing their functions and duties as directors. These include:

■ The right to have the company’s affairs administered in accordance with the company’s Constitution and the law.

■ The right to remain in office until validly removed. ■ The right to have access to the company’s financial

records and other corporate information. ■ Finally, in some circumstances a director will also be

entitled to engage external advisers at the company’s expense to advise the director in relation to the performance of his or her duties. But to do so, the director must be carrying out his or her duties of office in good faith in the normal course of business. They must also honestly and reasonably believe that his or her duties require the incurring of the expense in the interests of the company. It is often prudent for a director to seek the approval of the board or at least the chairperson before engaging external advisers in these circumstances.

The ‘business judgment rule’ and the statutory duty of care and diligence

As noted above, a director or other officer of the company must exercise their powers and discharge their duties with the degree of care and skill that a reasonable person would exercise if they:

■ Were a director or officer of a company in the company’s circumstances.

■ Occupied the office held by, and had the same responsibilities within the company as, the director or officer (section 180(1) of the Act).

To protect directors, the Act includes a defence known as the ‘business judgment rule’. A director or officer who makes a ‘business judgment’ (as defined) is taken to meet the requirements of both section 180(1) of the Act and their equivalent duties at general law in respect of the judgment if they:

■ Make the judgment in good faith for a proper purpose. ■ Do not have a material personal interest in the subject

matter of the judgment.

■ Inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate.

■ Rationally believe that the judgment is in the best interests of the company.

The director’s or officer’s belief that the judgment is in the best interests of the company is deemed to be rational, unless the belief is one that no reasonable person in the director’s position would hold.

A ‘business judgment’ is defined as ‘any decision to take or not take action in respect of a matter relevant to the business operations of the corporation’. A ‘business judgment’ therefore requires that the director actually make a decision on a matter. A failure to consider the matter will not fall within the scope of this statutory protection.

Further, the obligation that the director or officer inform themselves about the subject matter to the extent they reasonably believe to be appropriate requires that the director or officer give active consideration to the matter.

The word ‘reasonably’ indicates that an objective test will apply.

It is important to note that the statutory business judgment rule applies only to the duty of care and diligence (and equivalent general law duties). It does not apply to other duties imposed under the Act or other legislation (eg the Competition and Consumer Act 2010 (Cth)). Also, if a breach of section 180(1) of the Act involves a breach of another section of the Act, which section has its own statutory defence, the statutory business judgement rule will not apply. In addition, the courts have developed a form of business judgement rule which applies to the broader set of directors duties, both under statute and at general law.

For more information, please contact:

David Morris Partner T +61 2 9286 8371david.p.morris@dlapiper.com

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