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Directors Duties: Know What You’re Doing!

Both directors of publicly listed and proprietary companies face the complexities of business decision- making. They also face compliance with statutory and common law director’s duties. Directors who are found breaching these duties may be held personally liable and receive heavy fines or even gaol time.

According to ASIC, as of 4 October 2007 liquidator reports led to 68 directors being banned for a total of 230 years (an average of almost 3.5 years per ban) for various breaches of director’s duties.

The most notable Australian case involving a breach of director’s duties was the infamous HIH scandal. HIH directors Ray Williams and Rodney Adler were both committed to gaol for four and a half years for grossly breaching their duty to act in the best interests of their company. Both Williams and Adler were ordered to jointly pay $7 million in compensation. In addition to this, Williams and Adler were required to pay $250,000 and $450,000 respectively in pecuniary penalties with Adler prohibited from acting as a director for 20 years, whereas Williams was banned for 10 years.

Director’s duties include the following, and are enumerated in the Corporations Act 2001 (Cth) (“CA”):

A duty of care and diligence: s 180 CA

Directors have a duty to exercise their powers with the degree of care and diligence of a reasonable person in a like position in a similar company. So when a director makes a business decision he or she is taken to have discharged their duty of care and diligence if:

  • The decision was made in good faith and for a proper purpose;
  • They do not have a significant personal interest in the decision;
  • They have informed themselves about the subject matter of the decision; and
  • They believe the decision is in the best interests of the company.

Improper use of information: s 182 & 183 CA

  • A person who obtains information because he or she is, or has been a director, officer or employee of a company is prohibited from improperly using that information to gain an advantage  for themselves or someone else or to cause detriment to the company.
  • An example of this is the Vizard case (ASIC v Stephen Willam Vizard [2005] FCA 1037). The case involved Vizard using his position as a non executive director of Telstra to pass on market sensitive information to a company that he had a strong beneficial interest in. That company made share purchases and sales on Mr Vizard’s information and accumulated profits for him on those actions. Because a contravention of this duty attracts a civil penalty provision under s 183(1) of the Corporations Act, the court ordered Mr Vizard to pay a penalty of $390,000 and imposed a 10 year ban from directorship of any other company.

Duty to prevent insolvent trading: s 588G CA

  • Directors have a duty not to let the company trade and incur other debts while it is insolvent. This means that if the company does not have money to pay its debts it must cease trading until those debts have been paid.
  • Insolvent trading occurs when a reasonable person, when reviewing the financial circumstance of a company, would come to the conclusion that the company is incapable of meeting its debts.
  • In ASIC v Edwards [2006] NSWSC, the defendant director was disqualified from managing a corporation by allowing the company to incur debts of $3.5 million that it could not pay back.

Duty to act in good faith: s 181CA

  • A director must use their powers in good faith for the best interests of the company.
  • In Mills v Mills (1938) 60 CLR 150 at 195 Dixon J observed that “directors of a company are fiduciary agents, and a power conferred upon them (in their capacity as directors) cannot be exercised in order to obtain some private advantage or for any purpose foreign to the power”.

Generally, enforcement of directors’ duties falls upon ASIC to initiate proceedings in the relevant court. ASIC may apply under sections 180-183 and s 588G for civil penalty provisions which attract pecuniary penalties in addition to criminal sentences. Pecuniary orders applied for by ASIC and imposed by the courts can range from relatively small amounts to $1 million. Prison time imposed can range up to 5 years depending on the seriousness of the breach.

The reason for directors’ duties and their strict enforcement is to maintain confidence of shareholders and other stakeholders in Australian companies. The duties ensure that the directors act responsibly with the capital entrusted to them by their shareholders as well as financial lending institutions.

If you are a company director seeking to structure a transaction you should make sure your transaction or decision does not breach any of the directors’ duties. Sound legal advice should obtain before making a final decision as the consequences of any breach may be devastating.

If you have any specific or general questions in relation to this article, please do not hesitate to contact us.