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Directors’ duties are generally seen as an importance
At the same time, however, the law strives to achieve a balance between ensuring that directors are accountable, while allowing them the freedom to make decisions that involve business judgments and entrepreneurial risks without any threat of liability.
2.1 Directors’ Duties - Care, Diligence and Skill
Section 180 (1) of the Corporations Act 2001 provides that it is the duty of company directors to exercise their power and discharge their duties with the degree of care and diligence that a reasonable person would exercise. The section imposes an objective standard of a ‘reasonable person’—that is what an ordinary person, with the knowledge and experience of the defendant, might be expected to have done in the circumstances if the defendant were acting on his or her own behalf.
The duty of care also arises under the general law and may also arise under a contract of service that exists between a director and the company.
The standard of care referred to in Section 180 was interpretationed by the New South Wales Court of Appeal in the case of Daniels v AWA Ltd (1995) 13 ACLC 614. The Court held that the minimum standards of care, skill and diligence expected of all directors are that:
A director must acquire a basic understanding of the business of the company and must be familiar with the fundamentals of the company’s business
Directors are under a continuing obligation to keep informed about the activities of the company
Detailed inspection of the day-to-day activities is not required but what is required is a general monitoring of the company’s business affairs. A director should attend board meetings regularly
Although directors are not required to make an audit of the company’s books directors should be familiar with the financial status of the company which includes conducting regular reviews of financial statements.
The statutory duty of care contains a ‘defence’ within the section for directors charged with a breach of the duty, known as the business judgment rule. The business judgment rule is expressed in Section 180 (2) and permits a director or other officer of a corporation who makes a business judgment to meet the duty of care and diligence owed under Section 180 (1) if the director or officer:
made the judgment in good faith and for a proper purpose
does not have a material personal interest in the subject of the business judgment
has informed themselves about the subject matter of the business judgment to an appropriate standard
rationally believes that the business judgment is in the best interests of the corporation.
Although, the director or officer’s belief that the business judgment is in the best interests of the corporation will only be regarded as rational if is it judged that a reasonable person in their position would have the same belief.
It should also be noted that directors can delegate any of their powers under Section 198 D of the Corporations Act 2001. However, the directors remain responsible for the exercise of power by a delegate unless the conditions of Section 190 are met. This generally requires that the director believed on reasonable grounds that the delegate was reliable and competent and would exercise the power in accordance with the duty imposed upon directors.
2.2 Directors’ Duties - Good Faith and Proper Purpose
Section 181 of the Corporations Act 2001 imposes a statutory duty on directors and other officers to exercise their powers and discharge their duties in good faith in the best interests of the corporation and for a proper purpose.
A director must act with the utmost good faith towards the company. This is a statutory obligation as well as a common law obligation. At its most basic, the duty requires that directors act honestly and in the best interests of the company and its members. This may involve balancing the interests of different members or groups of members of the company who have different interests. If a decision is made knowing that it cannot be in the overall best interests of the company, then that will not be acting honestly even if it was not intend to defraud anyone.
A director may receive information in their role as director that will have a commercial value. A director must not use this information against the company or to advance the director's own private interests (Section 182 (1) (a)). The director must not make improper use of this information to obtain, indirectly or directly, a gain or advantage for the director or any other person, or to cause a detriment to the company (Section 182 (1) (b)).
A duty is imposed upon directors by Section 191 of the Corporations Act 2001 and requires that where a director has a material personal interest in a matter relating to the affairs of the company, other directors must be given notice of the interest unless there is an exemption.
The duty of a director is to look after the welfare of the company as a whole. The Law recognises the company as an entity in its own right, which has its own interests and needs. Since the company can act only through the directors and other company officers and employees who work for it, the company directors must take responsibility for what the company does and for what happens to it. A director must put the company's best interests ahead of their own personal interests.
2.4 Directors’ Duties - Insolvent Companies
Section 588 G of the Corporations Act 2001 imposes a duty on the director of a company to prevent his or her company from trading while insolvent. A director contravenes the section if, when the company incurs a debt, there are reasonable grounds for suspecting that the company is insolvent and would become insolvent.
There are four defences to Section 588 G and these are set out in Section 588 H. The defences are:
At the time when the debt was incurred, it could be proved that the director had reasonable grounds to expect, and did expect, that the company was solvent at that time (Section 588 H (2)).
The director could prove that he or she had reasonable grounds to rely on information provided by a competent and reliable person that the company was solvent (Section 588 H (3)).
A director did not take part in the management of the company because of illness or for some other good reason at the time when the company incurs the debt in question (Section 588 H (4)).
The director could prove that he or she took all reasonable steps to prevent the company from incurring the debt (Section 588 H (5)).
An insolvent company or a company nearing insolvency owes a duty to take account of the interests of creditors because these creditors have a right to be fully informed. The interests of the creditors in respect of the allocation of resources would be related to the ability of the company to realise the company’s current assets and the effect of its contingent liabilities. These interests of the creditors would oblige the company through the directors to declare whether or not there are reasonable grounds to believe that it will be able to pay its debts when they become due and payable (Section 295 (4) (c)). Such interests would also be served in the duty to prevent a company from trading while insolvent under (Section 588 G).
2.5 Directors’ Duties - Remedies for breaches
If directors’ duties are breached, the ASIC or the company can apply to the court for a declaration of contravention (Section 1317 E). A court may order a director to pay a civil penalty involving a pecuniary penalty order or a fine of up to $200,000 if the contravention adversely affects the interests of the company or its ability to pay its creditor (Section 1317 G). The court may also order the director to compensate the company for damage (which included profits made) suffered as a result of the contravention (Section 1317 H).
Directors would be liable for a criminal offence if they contravene a civil provision knowingly, intentionally or recklessly; and intending to deceive or defraud. The penalty here is a $200,000 fine or imprisonment for five years or both (Section 1317 P).
More specifically, Section 184 of the Corporations Act 2001 provides that if directors fail to exercise their powers in good faith in the best interests of the company, the director would be guilty of a criminal offence. The penalty for such an offence is a $220,000 fine or imprisonment for five years or both.
The balance between entrepreneurial risk-taking and a director’s corporate responsibility are inversely correlated under current law. Directors must be able to make decisions which inevitably involve some degree of commercial risk if the economy is to be advantaged. Likewise, careless and dishonest director behaviour must be discouraged if shareholder interests are to be adequately protected. Australian corporate law has attempted to strike this balance through the enactment of provisions such as the business judgment rule contained in Section 180 (2) of the Corporations Act 2001. This rule was introduced for the purpose of protecting and providing deference to directors in making management decisions.
As stated by Ipp J in Vrisakis v Australian Securities Commission
‘The management and direction of companies involves taking decisions and embarking upon actions which may promise much, on the one hand, but which are, at the same time, fraught with risk on the other. That is inherent in the life of industry and commerce.’
In this sense, it seems that the business judgement rule disregards the notion of short and long term decision making. The juxtaposition between short and long term risk adoption will always cause conflicting views as to whether a decision was rational or irrational in the given circumstances. Under the current Section180 (2), the balance between a short term risk which returns significant shareholder value against that of a longer term, and more capital intensive risk, seemingly deters the former and rewards the later.
Under the current test, a director who undertakes short term entrepreneurial risks which require opportunistic responses to dynamic market changes would be unable to substantiate their position regardless of the positivity of the outcome. Some opposers of the business judgement rule, in its current form, feel that such risks fall outside of the scope of the Section 180 (2) and deter directors from capitalising on significant environmental changes that are both opportunistic and value adding, but also hold too great a legal risk to justify. This could be seen as a why the business judgement rule has been scarcely the subject of Australian case law.
So where does that leave directors and officers in terms of understanding their risk and their ability to be entrepreneurial?
The Courts have recognised that directors and officers need to be entrepreneurial when making decisions that are in the best interests of a company and this involves risk.
How directors and officers are perceived to have accounted for, measured and responded to risk, will determine whether they will have discharged their duty of care and diligence.
Directors will be allowed, where the extent of the law allows, to obtain expert opinions and rely on input of other parties, assisting in showing their duties have been discharged.
In Australia, and in other comparable countries, directors may be exposed to significant personal liability if they do not conduct themselves with appropriate levels of care and loyalty in accordance with their statutory obligations. The existence of potentially significant civil liability for breach of directors’ duties, and the possibility of criminal sanctions in some cases, is a useful disincentive against suspect conduct and an incentive for reasonable care. The outcome is that directors who conduct themselves with reasonable care and honesty are most unlikely to be found liable.
On one hand, it appears that a sensible balance between too much directors’ liability and not enough has been struck. But on the other hand, it appears that the law in its current form takes an adverse approach and enforces strict liability on directors who cause corporate loss with the business judgement rule contained in Section 180 (2) which does nothing to advance the entrepreneurial cause.