Duties of directors and officers Duties of directors and officers

Corporate Law: Law principles and practice The director’s and the board’s duty of care The duty of reasonable care and skill—a duty to be reasonably competent and proficient in carrying out their tasks—is owed by the directors to the company and is relational in this sense, given that they are: on the board of the company and paid a director’s fee if they attend as a non-executive director employed by the company as a full-time executive director and attending the board meeting in that capacity Directors have both contractual and tortious obligations towards the company.

Corporate Law: Law principles and practice Relevant statutory provisions Section 179(1) of the Corporations Act 2001 (Cth) sets out some of the most significant duties of directors, secretaries, other officers and employees of corporations. Other provisions of the Act, as well as other laws (including the general law), impose other duties on these parties. Section 179(2) refers to the definition of ‘officers’ in s 9 and states that officers can be not only directors and secretaries, but also other people who manage the corporation or its property (such as receivers and liquidators).

Corporate Law: Law principles and practice Duties of directors and officers Directors and officers have both common law and statutory fiduciary duties Directors owe fiduciary duties to the corporate entity itself (e.g. the duties of skill and care). A breach may result in a criminal offence involving a fine, imprisonment, personal liability, disqualification from being a director, or having to return funds to the company. ‘Fiduciary’ refers to trust and confidence. A fiduciary agrees to act for, or on behalf of, or in the interests of, another person in the exercise of a power or discretion that will affect the interests of that other person in a legal or practical sense. Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41.

Corporate Law: Law principles and practice Historical standards of diligence and care Re City Equitable Fire Insurance Company Ltd (1925) Ch 407 The degree of skill to be exercised by a director is not an objective standard, but is gauged by reference to the director’s particular knowledge and experience. The director need not give continuous attention to a company’s affairs. Delegation by the directors to others is permissible, as long as the circumstances are not suspicious.

Corporate Law: Law principles and practice Duties of directors Directors can no longer claim that they didn’t know about, and consequently are not responsible for, company activities. Statewide Tobacco Services Ltd v Morley (1990) 8 ACLC 827

Corporate Law: Law principles and practice The business judgement rule: s 180 (2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment if they:directorofficercorporation business judgmentjudgment (a) make the judgment in good faith for a proper purpose; andjudgment (b) do not have a material personal interest in the subject matter of the judgment; andhavepersonalinterestjudgment (c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and judgment (d) rationally believe that the judgment is in the best interests of the corporation.judgment interestscorporation

Corporate Law: Law principles and practice Duties of directors cont … The bigger the company and the greater the amount the directors are paid, the more is expected in terms of skill and judgment compared to in a small company.

Corporate Law: Law principles and practice The contemporary standard of care ASIC v Healey: the ‘Centro litigation’ The directors and officers of this company did not discover that the financial reports they signed off on were seriously incorrect. ‘The directors failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them.’

Corporate Law: Law principles and practice Considering the Centro decision The Centro directors’ defence was that they were entitled to rely on the advice of their specialist managers and of their auditors, PricewaterhouseCoopers. This did not excuse the directors for not finding the error for themselves.

Corporate Law: Law principles and practice Centro cont… Only one of the Centro directors had an accounting qualification. Should the directors (who were usually given board papers about 450 pages long) have been focused on the detail of the financial statements presented to them by their management and auditors, or on matters of economic substance? Should the directors have had sufficient knowledge of accounting standards to be able to second-guess the experts they were paying to ensure the accounts conformed to the standards?

Corporate Law: Law principles and practice Further statutory duties applying to directors The following are covered in part 2D.1 of the Corporations Act 2001 (Cth): s 181 Good faith—civil obligations Good faith—directors and other officersofficers (1) A director or other officer of a corporation must exercise their powers and discharge their duties:directorofficercorporation (a) in good faith in the best interests of the corporation; andinterests corporation (b) for a proper purpose.

Corporate Law: Law principles and practice s 182 Use of position—civil obligations Use of position—directors, other officers and employeesofficers (1) A director, secretary, other officer or employee of a corporation must not improperly use their position to:directorofficer corporation (a) gain an advantage for themselves or someone else; or (b) cause detriment to the corporation.causecorporation

Corporate Law: Law principles and practice s 183 Use of information—civil obligations Use of information—directors, other officers and employeesinformationofficers (1) A person who obtains information because they are, or have been, a director or other officer or employee of a corporation must not improperly use the information to:personinformation havedirectorofficer corporationinformation (a) gain an advantage for themselves or someone else; or (b) cause detriment to the corporation.causecorporation Australian Securities and Investments Commission v Vizard [2005] FCA 1037

Corporate Law: Law principles and practice Section 184 Good faith, use of position and use of information—criminal offences Good faith--directors and other officersofficers (1) A director or other officer of a corporation commits an offence if they:directorofficercorporation offence (a) are reckless; or (b) are intentionally dishonest; and fail to exercise their powers and discharge their duties: (c) in good faith in the best interests of the corporation; orinterests corporation (d) for a proper purpose.

Corporate Law: Law principles and practice S 184 Cont … Use of position—directors, other officers and employeesofficers (2) A director, other officer or employee of a corporation commits an offence if they use their position dishonestly:directorofficer corporationoffence (a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; orcorporation (b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation.resultcorporation

Corporate Law: Law principles and practice S 184 Cont … Use of information—directors, other officers and employeesinformationofficers (3) A person who obtains information because they are, or have been, a director or other officer or employee of a corporation commits an offence if they use the information dishonestly:personinformation havedirectorofficer corporationoffence information (a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; orcorporation (b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detrimentresult to the corporation.corporation

Corporate Law: Law principles and practice Parties within the company who have a fiduciary duty Chair–company Director–company CEO–company Manager–company All employees–company Officers–company

Corporate Law: Law principles and practice The company context Directors owe their primary duty of allegiance to the company (as a separate legal entity) and not to the shareholders, creditors or fellow directors. Percival v Wright (1902) Ch D 421 Courts, when dealing with director’s fiduciary duties, have taken the following approach: They will not generally interfere with commercial decisions taken by the directors. They will concentrate on abuses of trust and confidence and the manner in which directors have exercised their discretionary powers.

Corporate Law: Law principles and practice Duties on directors The Common law imposes duties on directors, including: Directors cannot make secret profits out of their position. If directors were to make secret profits out of their position, they hold such profits as constructive trustees (the company being the beneficiary) and must account to the company for them (that is, return them). Information directors receive in relation to their position is the company’s property. Directors may, depending on the circumstances, have to disclose information to the shareholders.

Corporate Law: Law principles and practice Duties on directors cont … Directors cannot compete with the business during their term of office. After they depart the business, directors are bound to comply with certain terms of departure including: a reasonable restraint of trade clause non-disclosure of trade secrets.

Corporate Law: Law principles and practice Civil and criminal liability of directors ASIC can prosecute under the Corporations Act 2001 (Cth), which specifies several areas of civil liability and criminal liability. The standard of proof for a civil matter is the balance of probabilities; for a criminal matter, see s 184. Kwok v Regina [2007] NSWCCA 281

Corporate Law: Law principles and practice Other relevant provisions of the Act Division 2 of the Corporations Act 2001 (Cth) provides: s 191 Material personal interest—director’s duty to disclose: a director needs to give notice to the company of a ‘material personal interest’ when a conflict of interest arises, unless excepted under s 191(2). s 192 Director may give other directors standing notice about an existing conflict. Directors can give a pre- emptive notice of a material conflict. s 194 Voting and completion of transactions-directors of proprietary companies: a director of a proprietary company may vote once they have disclosed their material personal interest.

Corporate Law: Law principles and practice Other relevant provisions of the Act cont … s 195 Restrictions on voting—directors of public companies only: public company directors should not be present or vote on matters in which they have a material personal interest. S 196 ASIC power to make declaration and class orders: ASIC has the power to declare a material personal interest in the case of a public company director. Note: private companies—after disclosure of the interest, the director can vote on the matter, as per s 194 public companies—after disclosure of the interest the director should not be present or vote on the matter, as per s 195.

Corporate Law: Law principles and practice The board and insolvency issues The board must manage a company and use professional delegates to ensure the company is solvent. Companies must implement appropriate policies and reporting systems to ensure the company is solvent. The CFO reports to the directors on the company’s finances. A regular audit must be held which effectively and independently verifies the finances. Directors must sign off on the company financial reports as true and fair view (Corporations Act 2001 (Cth) ss 297, 308)

Corporate Law: Law principles and practice Statutory provisions for solvency Directors have a duty to prevent insolvent trading by the company. Companies require sufficient funds to pay their debts as and when they fall due (Corporations Act 2001 (Cth) s 588G). The test applied to the directors is that of the ‘reasonable person in a like position in a company in the company’s circumstances’, as per s 588G(2). Elliott v Australian Securities and Investments Commission; Plymin v Australian Securities and Investments Commission [2004] VSCA 54 (7 April 2004 )

Corporate Law: Law principles and practice Statutory provisions for solvency Section 588G of the Corporations Act 2001 (Cth): the director's duty to prevent insolvent trading by company. (1) This section applies if: (a) a person is a director of a company at the time when the company incurs a debt; andpersondirectorcompany (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; andcompanyinsolvent (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; andcompanyinsolvent (d) that time is at or after the commencement of this Act.commencementthis Act

Corporate Law: Law principles and practice Corporations Act 2001 (Cth) Section 588H defences (1) This section has effect for the purposes of proceedings for a contravention of subsection 588G(2) in relation to the incurring of a debt (including proceedings under section 588M in relation to the incurring of the debt).subsection 588G(2) section 588M (2) It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.provedpersoncompanysolvent

Corporate Law: Law principles and practice s 588H cont … (3) Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the person:limitingprovedperson (a) had reasonable grounds to believe, and did believe: (i) that a competent and reliable person (the other person) was responsible for providing to the first- mentioned person adequate information about whether the company was solvent; andperson adequateinformationcompanysolvent (ii) that the other person was fulfilling that responsibility; andperson (b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any otherinformationprovidedperson companysolvent debts that it incurred at that time.

Corporate Law: Law principles and practice s 588H cont … (4) If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.persondirectorcompanyprovedcompany (5) It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.provedpersoncompany (6) In determining whether a defence under subsection (5) has been proved, the matters to which regard is to be had include, but are not limited to:provedlimited (a) any action the person took with a view to appointing an administrator of the company; andperson administratorcompany (b) when that action was taken; and (c) the results of that action.results