Over the last 20 years, we have witnessed a growing number of memorable corporate collapses which in many instances have been directly attributable to the behaviour of directors. As in an air crash investigation, a ‘pilot error’ is often the case.
These collapses have invariably caused financial grief to workers, investors, suppliers and others. Such catastrophic events have caused the Australian government to arm the regulator, principally ASIC, with ever-increasing powers to enforce corporate governance. Through a number of high profile cases, such as Qintex (1989), Hih (2001), Onetel (2001), Bankwest (2008), Storm Financial (2009) and Dick Smith (2016) one finds key examples of ASIC flexing its regulatory muscles and ensuring directors are held to personal account. Long gone are the days of immunity for merely being a director and ASIC being a toothless tiger.
To better understand directors’ duties, Dennis Martin, Director of Snedden Hall & Gallop Lawyers, provides a three-part blog series that will journey back through a brief historical overview, and then look at the difference in duties for directors of a corporation compared with those of an officer of an incorporated association. Here, in part one, we look at critical directors’ duties. For more information go to:
Part 2: Significant cases that have shaped directors duties
Part 3: What if you are an officer of an incorporated association?
What are the different types of directors?
There are two types of directors: formal and informal. Formal directors are appointed and include executive, non-executive, alternate and nominee directors. Informal directors are not appointed but have significant influence in controlling the company and include de-facto and shadow directors. Our discussion will be dealing with formal directors – however, there are avenues for ASIC to also hold informal directors to account.
What are the 4 key directors duties?
Overarching the common law and statutory duties, the role of a company director is to govern a company on behalf of the shareholders or members of that company.
The laws found in the Corporations Act 2001 (Cth) are designed to reflect the common law standard of director duties. Importantly, the provisions aim to promote good governance and limit conflicts of interest between directors and their companies. Importantly, it aims to prevent directors from taking advantage of their position in order to advance their own interests over the interests of the company.
There are four main duties found in the Corporations Act:
- Duty to act with reasonable care, skill and diligence (including the duty to prevent insolvent trading). Under s180, this duty requires a director to act with a degree of care and diligence that a reasonable person might be expected to show in the role. Common law places great weight on this duty with respect to approval of financial statements [Centro, 2011] and statements issued by a company [James Hardie, 2012]. Further, risky transactions without the prospect of producing a benefit, or failure to inform board members of significant issues can create a breach of this duty. The extent of this duty is dependent on a range of circumstances. These include the type of organisation, the size and nature of the business and the composition of the board [ASIC v Rich, 2009]. Also, if a particular director holds out to possess certain expertise to obtain the directorship, the director’s exercise of care and diligence will be assessed against that expertise. For example, if a director holds out that she has specialised financial knowledge and she occupies a financial role, her accountability for the organisation’s finances will be higher compared with an ordinary director [ASIC v Adler, 2002]. Moreover, non-executive directors still have a duty to acquire at least a rudimentary understanding of the business of their organisation. Even if it is practice for a non-executive director to be unaware of the organisation’s circumstances, the position of a director comes with the responsibility of a core irreducible standard [Daniels v Anderson, 1995]. There is, however, the business judgment rule which could protect a director in relation to a claim for breach of this duty. This essentially requires directors to make a judgment that they rationally believe is in the best interests of the organisation. A judgment is considered to be rational unless no reasonable person in the director’s position would consider it rational.
- Duty to act in good faith in the best interests of the organisation and for a proper purpose is a two-part rule. The rule requires a director under section 180(1), to act honestly, fairly and loyally in furthering the interests of their organisation. This means that you have to place the interests of the organisation above your own when making decisions. Directors are also required to act for ‘proper purposes’, meaning that decisions are made for the purpose of benefiting the organisation. To determine if one has breached this duty, it is important to ask whether the director subjectively believed that what they did was in the best interest of the company. If the answer is ‘yes’, then the next question is whether the belief was so unreasonable that no reasonable board of directors would have made the same decision. If the answer is again ‘yes’ then it is likely that a director may have breached this duty.
- Duty not to improperly use information or position. Section 183 requires directors to use the information they gain in their role as director to benefit the organisation rather than themselves. Directors are in a position of power and authority and have access to confidential information. As such, if a director uses the information they gain in their role for personal advantage or to cause detriment to the organisation then the director may be liable for breaching this rule.
- Duty to disclose and manage conflicts of interest. It is not uncommon for directors to encounter situations where a conflict of interest may arise. Whilst directors have a duty to avoid conflicts of interests having a conflict of interest is not necessarily a breach of this duty. As such in these situations, under section 191 directors must notify other directors of their personal interest when a conflict arises. Further, you must avoid taking part in board decisions that relate to your conflict of interest. This is to ensure that directors are placing their organisation ahead of themselves.
How can Snedden Hall & Gallop assist?
If you are the director of a company, understanding the duties that position entails are important. Dennis Martin can assist you in understanding the roles of directors and provides assistance if you are concerned that you may have breached a directors duty. You can contact him for any commercial matter on (02) 6285 8000 or by email.
This is the first in a three-part blog series. Have a look at part 2: a historical overview and part 3: issues facing the officers of an association.