The role of a company director is to govern a company on behalf of its shareholders or members. Arising from this role, and the powers that come with it, are a variety of duties that directors owe to the company. In essence, a director is bound to exercise their powers in the best interests of the company. Depending on the size and structure of the company, the various duties that a director will be required to comply with can often be plentiful. Many of these duties automatically place significant onuses on the director to conduct themselves a certain way – and breaching those duties can have significant consequences.
Who are directors’ duties owed to?
Directors must act for the benefit of the company as a whole. This means that directors must act in the interest of all the members or shareholders of the company communally. However, directors may sometimes be permitted or required to take other interests into account, including those of:
- individual members
- creditors
- wholly owned subsidiaries
- employees
- corporate groups
- the community at large
Although directors will sometimes take the interest of a particular party or parties into account that in some way may collide with the interest of various other members of the company, the director’s decision should ultimately be based on their beliefs as to what actions will be in the best interest of the company as a whole.
Corporate governance
The term “corporate governance” refers to a system of policies, rules and processes that direct and control a company’s general “behaviour”. In essence, it is a framework that defines the relationship between shareholders, company management, the board of directors, and other key stakeholders, with the main goal to ensure that companies are controlled in a way that is based on legal and ethical principles, and further, to ensure directors can be held accountable for their actions in the event that they proceed to act against the interest of the company and its members as a whole.
The concept of what constitutes “good” corporate governance has been continuously developed since the 1990s with the aim to incentivise company directors to balance the duties they owe to company’s stakeholders with the interests of the community at large (specifically in relation to acting ethically and responsibly).
There are mechanisms that play a particularly important role in corporate governance by ensuring that companies are directed and controlled in a matter that protects and promotes the interest of all relevant participants and stakeholders. Obviously, each mechanism will have a different degree of influence depending on the type of company in question; some mechanisms may not even have any relevance to a company at all, depending on that particular company’s structure.
Some of the most important mechanisms covered by the corporate governance framework include:
- directors’ legal duties
- auditors’ duties
- institutional investors’ duties
- general officers’ legal duties
- structure of the board of directors
- takeovers
Directors’ duties are regulated specifically to ensure not only that directors conduct themselves in a way that benefits the company as a whole, but also to ensure they act in a way that benefits the company’s stakeholders, both individually and collectively.
Certain mechanisms of corporate governance will impact specific types of companies more than others. For example, directors’ duties imposed by statute cannot be avoided without consequence and will therefore carry obligations on directors of all different types of companies, whereas directors of companies listed on the Australian Stock Exchange will have duties and requirements imposed on them that relate only to larger, publicly listed companies.
Practising good corporate governance, including ensuring that directors adhere to the obligations imposed on them through their directors’ duties, aims to bolster the confidence of investors and, through that, boost general economic growth and stability.
Sources of directors’ duties
In Australia, the obligations imposed on directors through their directors’ duties are generally determined by specific regulations and guidelines relating to the particular “source” of those duties. Directors’ duties can generally be divided into the following “source categories”:
- duties owed under the Corporations Act 2001 (Cth) (the Act);
- fiduciary duties;
- common law duties;
- duties owed under a company constitution; and
- other statutory duties, such as those which arise through the Australian Securities and Investment Commission Act 2001 (Cth), or under tax legislation.
Companies are primarily governed by the Act. The primary purpose of the Act is to set out the obligations of a company and its board of directors, executives and other members and stakeholders.
Fiduciary duties are equitable duties that are not expressly specified or stipulated in legislation. However, they work hand in hand with statutory duties. A director of a company will owe a fiduciary duty to the company, which means that they must act in good faith, as well as in the company’s best interest, at all times.
What are the duties owed by a director of a company?
In performing their role, directors are subject to statutory, fiduciary and common law duties, as well as any regulations stipulated in the company’s constitution (if the company has one). Many of these duties overlap, and the consequences of breaching these duties can often be severe. In some circumstances, a director breaching their duties can even result in the director being held personally liable for debts owed by the company.
Part 2D.1 of the Act sets out a director’s general powers and duties, as well as the powers and duties of other officers and employees.
The principal duties owed by directors include:
Duty of care and diligence (s 180)
Directors have a duty to act with the degree of care and diligence that a reasonable person would be expected to show in that role. More specifically, this means that directors must exercise their powers and discharge their duties with a degree of care and diligence that it would be expected that a reasonable person would exercise if they were a director of that particular company in the same circumstances (i.e. occupying the same office and having the same responsibilities and powers within that company).
Directors also have a duty to take reasonable steps to prevent compliance failures where the potential failure creates a foreseeable risk of harm to the company itself. Essentially, in order for any act or omission of the director to be capable of constituting a contravention of section 180, there must be a reasonably foreseeable risk of harm that could affect the interest of the company, and to which the director failed to prevent.
Duty of good faith and the interest of the company (s 181)
Directors have a duty to act in good faith and in the best interest of the company, and to exercise their powers and duties for a proper purpose. This includes avoiding conflicts of interest, as well as revealing and managing conflicts if and when they arise. At a minimum, the duty of acting in good faith requires directors to act in a manner they honestly believe to be in the best interest of the company as a whole. Furthermore, a director’s general conduct may be assessed by reference to what a reasonable director in that same position would consider proper in the circumstances.
Duty to not improperly use position (s 182)
Directors have a duty to not use their position for an improper purpose, such as to gain an unjust advantage for themselves or someone else, or to cause detriment to the company in some way.
Duty to not improperly use information (s 183)
Directors have a duty not to improperly use information they have gained by virtue of their position in the company to gain an unjust advantage for themselves or someone else, or in some other way cause detriment to the company. This duty frequently overlaps with the duty of directors to not use their position for an improper purpose and commonly arises in matters involving insider trading.
Duty to prevent insolvent trading (s 588G)
Directors have a duty to ensure that a company’s operation is as economically efficient and sustainable as possible. Part of this duty involves ensuring that the company has sufficient resources to pay its debts as and when they fall due. This is the key indicator to determine whether or not a company is solvent. A company is prohibited from trading while insolvent, and directors have a key duty to prevent insolvent trading.
Generally, if a company is found to have traded while insolvent, the company’s directors may be held personally liable for debts or losses incurred by the company. Breaching this duty may also result in the Australian Securities and Investments Commission (ASIC) imposing fines or even disqualifying directors from acting as a director.
Duties relating to financial reporting (chapter 2M)
Directors have a duty to keep written financial records reflecting the company’s financial transactions and general financial position and performance, as well as preparing financial statements reflecting the true and fair financial position of the company. For listed companies, this duty extends to continuous disclosure of information that may affect the company’s share price, including making this information available to the stock market at large.
A director who breaches their duties relating to financial reporting may be held personally liable for any loss and damage caused.
The main purpose of enforcing duties imposed on directors was informatively discussed in the case of Termite Resources NL (in liq) v Meadows (2019) 370 ALR 191, where the court stated:
“Making mistakes does not by itself demonstrate lack of due care and diligence … Directors and officers of corporations are expected to take calculated commercial risks. A company run on the basis that no risks were ever taken would be unlikely to be successful. The proper taking of risk in making business decisions is entirely consistent with exercising care and diligence. The proper assessment of the risks and potential rewards is a matter that demands the exercise of care and diligence. The two concepts complement each other in the management of corporations: Australian Securities and Investments Commission v Lindberg (2012) 91 ACSR 640; [2012] VSC 332 at [72]”.
In addition to duties arising under the Act, statutory duties imposed on directors include general tax laws, competition and consumer laws, and occupational health and safety laws and regulations. Additionally, certain industries have specific laws creating obligations that are only relevant to that particular industry (e.g. aviation law and mining law).
What are the consequences of breaching your directors’ duties?
In Australia, directors can be exposed to significant liability for breaching their directors’ duties, both in civil and criminal law. Some consequences that may flow from a director breaching their directors’ duties include, but are not limited to:
Criminal sanctions
Failure to comply with certain duties under the Act can lead to significant criminal sanctions, including imprisonment.
Commercial consequences
Failure to comply with certain duties may result in the company being subjected to scrutiny, both by regulators and by investors. This may lead to loss of reputation, both in regard to the company as a whole and the director personally.
Civil liability
Failure to comply with certain duties may make a director liable to significant fines imposed by ASIC. Company creditors may also take action against directors who have failed to comply with their duties and who have caused the company to incur a debt or other liability.
Disqualification
If a director’s failure to comply with their obligations is severe, both the courts and ASIC may have the power to disqualify directors for a specified period of time.
For when you need help
As the consequences of breaching directors’ duties can be significant, it is extremely important that directors take their powers and responsibilities seriously. If you are a director of an Australian company, it is essential that you fully understand your powers and continuously comply with all your responsibilities in order to avoid inadvertently breaching one of the numerous obligations imposed on you.
If you have been accused of breaching your directors’ duties, it is important that you seek immediate legal advice in order to protect your rights and limit your personal liability.
Contact Gibbs Wright Litigation Lawyers today for a confidential initial consultation about your directors’ dispute matter.
