Directorship carries significant legal responsibilities, including fiduciary and statutory duties that may expose a director to personal liability if breached. A director may not be relieved of those legal responsibilities by reason of ignorance, delegation of functions, or reliance on information or advice provided by others, including professional advisers.
An overview of directors’ duties
Directors’ duties derive from common law, equity, the Corporations Act 2001 (Cth) (‘Corporations Act’) and other statutes. Breaches of these duties may result in separate causes of action, which may be pleaded concurrently. Given the overlap between the relevant legal principles, the principal duties are outlined below by reference to the statutory framework, with relevant authorities cited where appropriate to demonstrate their operation and application.
Duty to act with reasonable care, skill and diligence
Directors must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were a director of the company and occupied the same office, and had the same responsibilities, as the director in question.(section 180(1), Corporations Act).
In Daniels v Anderson (1995) 37 NSWLR 438, the Court held that a director’s duty of care is considered objectively. Accordingly, a director cannot rely on a lack of business experience, expertise or knowledge as an excuse for failing to exercise the degree of care and diligence expected of a reasonable person in the same position. Further, the objective standard may require more than a mere overview of the company’s affairs, as demonstrated by ASIC v Healy [2011] FCA 717 (Centro).
Statutory Duties relating to Financial Record Keeping and Reporting
In Centro the Court considered, among other things, whether the directors had breached their obligations under section 344(1) of the Corporations Act to take reasonable steps to ensure the company’s compliance with its financial reporting obligations. The directors failed to identify a material misclassification in the company’s financial statements, which resulted in the non-disclosure of significant liabilities, notwithstanding that the error had also been overlooked by management and the external auditors.
The Court held that the directors had failed to exercise the degree of care and diligence required in reviewing the financial statements. The Court observed that directors must apply their own minds to, and carefully review, financial statements placed before them. Reliance on management or external advisers cannot replace a director’s independent consideration of matters falling within the board’s responsibility. In these circumstances, the directors could not delegate or “abdicate” those responsibilities. The directors were found to have breached their duties despite being intelligent, experienced and conscientious individuals.
Accordingly, individuals considering a directorship should carefully assess their own financial literacy. Directors must exercise independent judgment and are expected to exercise independent scrutiny to the financial matters at hand, regardless of whether they have relied on general assurances from management or other professionals.
Business Judgment Rule
The business judgment rule section 180(2) of the Corporations Act provides directors protection when making informed decisions. It seeks to balance director accountability with the need to allow directors the freedom to make decisions involving commercial risk and uncertainty.
Section 180(2) of the Corporations Act operates as a defence to allegations that a director has breached the duty of care and diligence. To rely on the rule, a director must demonstrate that they made the relevant decision in good faith and for a proper purpose, had no material personal interest in the decision, informed themselves about the matter to the extent they reasonably believed was appropriate, and rationally believed the decision was in the best interests of the company. Section 180(3) defines a “business judgment” as any decision to take or not to take action in respect of a matter relevant to the business operations of a corporation.
Some commentators argue that the protection afforded by the rule is limited. In particular, the defence is available only in relation to breaches of the duty of care and diligence, places the onus on directors to demonstrate each of its elements, and has generally been applied cautiously by the courts. As a result, its practical utility as a shield against liability has been questioned.
Duty to Act in Good Faith and for a Proper Purpose
Section 181(1) of the Corporations Act imposes a duty on directors to exercise their powers and discharge their duties in good faith, in the best interests of the corporation, and for a proper purpose.
The duty to act in good faith is generally regarded as subjective, requiring directors to exercise their powers bona fide in what they consider to be the company’s best interests. However, the duty is not purely subjective. The authorities suggest that courts may have regard to objective circumstances when considering whether a director genuinely held that belief. In Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) (2008) 39 WAR 1, Owen J indicated that objective facts may be relevant in determining whether a director’s belief was honestly held. Likewise, in Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62, the Court considered whether an intelligent and honest person in the same position could reasonably have believed that the impugned conduct was in the company’s interests.
Ascertaining the best interests of the company is not always straightforward, as the interests of the company’s various stakeholders may not align. Generally, courts are reluctant to second-guess directors’ commercial judgments as to what is in the company’s best interests, provided those judgments are made in good faith and for a proper purpose (see United Petroleum Australia Pty Ltd v Herbert Smith Freehills [2018] VSC 347) (United Petroleum). However, particular stakeholder interests may assume greater significance in certain circumstances. For example, where a company is insolvent or approaching insolvency, directors must have regard to the interests of creditors (see Kinsela v Russell Kinsela Pty Ltd (in Liq) (1986) 4 NSWLR 722). Likewise, in a change of control context, the interests of shareholders may warrant particular consideration.
The requirement to act for a proper purpose confines directors to exercising their powers for the purposes for which those powers were conferred and in furtherance of legitimate corporate objectives. Directors who exercise their powers to advance their own interests, or the interests of a particular shareholder or group of shareholders at the expense of the company, are likely to breach this duty.
Duty to Not Improperly Use Position
Directors must not improperly use their position to gain an advantage for themselves or another person, or to cause detriment to the company (section 182, Corporations Act). Similarly, a person who obtains information by virtue of being, or having been, a director must not improperly use that information to gain an advantage for themselves or another person, or to cause detriment to the corporation (section 183, Corporations Act).
For the purposes of sections 182 and 183, impropriety involves “behaviour [that] breached the norm of conduct thought necessary for the proper conduct of commercial life so that people will have confidence that the running of the marketplace is in safe hands” (United Petroleum).
Manage Conflicts of Interest
Directors must avoid and actively manage any real or potential conflicts of interest. This includes identifying and recording any conflicts of interest to ensure transparency and oversight, and to decide whether the conflict can be effectively managed and the manner to do so.
Section 191 of the Corporations Act sets out a director’s duty to notify other directors of material personal interests that relate to the affairs of the company. The disclosure must be made as soon as the director becomes aware of the conflicts of interest, include sufficient details regarding the nature and extent of the interest and the relation of the interest to the affairs of the company, and be recorded in the minutes of the board meeting. Some limited exceptions apply.
For public companies, section 195 of the Corporations Act prohibits directors with a material personal interest from attending, participating in deliberations or voting on the matter, unless specific approvals are obtained.
Duty to Prevent Insolvent Trading
Directors have a positive duty to prevent insolvent trading under section 588G of the Corporations Act. Directors may be personally liable for debts which are incurred (a) if they were a director at the time the company incurs a debt; and
(b) the company is already insolvent at the time the debt is incurred or by incurring the debt the company becomes insolvent; and
(c) at the time of incurring the debt, there were reasonable grounds for suspecting that the company was already insolvent or would become insolvent.
Safe Harbour Provisions
The insolvency safe harbour protection set out in section 588GA of the Corporations Act protects directors from civil insolvent trading liability in certain circumstances. To invoke the protection, a director must demonstrate that, following a suspicion that the company is insolvent or may become insolvent, they began developing or implementing a course of action reasonably likely to achieve a better outcome for the company. The debt in question must have been incurred, directly or indirectly, in connection with that course of action and within the relevant statutory period.
The actions which the safe harbour provisions may cover is wide, as courts recognise that not all restructuring attempts will be successful. Although not a statutory requirement, obtaining advice from an appropriately qualified entity under section 588GA(2), Corporations Act is a prudent safeguard, as it may establish matters necessary to rely on the safe harbour defence and in discharging the evidentiary burden associated with that protection.
Obligations under other laws
There are other laws (including the Australian Consumer Law, workplace health and safety legislation, and tax legislation) which may apply to directors and could subject them to personal liability in the event of a breach.
Individuals considering a directorship should conduct their own due diligence and/or seek professional advice before consenting to assume office.
Summary:
- Individuals should conduct proper due diligence or seek appropriate legal advice prior to accepting a director position.
- Being a director to a company carries with it substantial legal obligations and duties.
- The general duties include a duty to act with reasonable care, skill and diligence, a duty to act in good faith and for a proper purpose, a duty to not improperly use their position, a duty to notify of material personal interests that relates to a company’s affairs, a duty to prevent insolvent trading, as well as statutory duties relating to financial record keeping and reporting.
- Other laws and specialised laws that are industry specific may also apply.
- Ignorance, delegation and/or reliance on information provided by other people or experts is not always enough to abdicate you of your duties.
- Courts have tended to construe directors’ duties strictly, reflecting an expectation that directors exercise a genuine standard of competence, and to invest the necessary time and attention to their duties.
This publication contains general information only and does not constitute legal advice. You should obtain professional advice tailored to your circumstances before acting on any information contained in this article.