The directors of a company – collectively referred to as ‘the board’ – are vested with authority to manage the company. A company must act through its authorised agents, the directors, and those acting under the authority of the board. Hence, companies can only contract through the signature of their directors and company secretary.
Directors (along with lawyers and trustees) are a classic category of fiduciary. This means they have both the power to alter legal rights of another entity, and the concomitant duty to ensure that their powers are used in the strictest good faith to ensure their power is not misused.
As officers of corporations, they are also bound to follow the requirements of the Corporations Act 2001 (Cth) (Corporations Act). As a result, directors have duties arising out of both the common law and statute.
Common Law Duties
A director owes duties to act in the best interests of the company. This involves:
1. The duty to act in good faith and for a proper purpose.
This duty requires directors to use their power to advance the interests of the company and all shareholders. While this does not generally include the interests of individual shareholders or employees, it can, in certain circumstances, extend to the interests of creditors, particularly where the solvency of the company is in question.
Directors are entitled to exercise business judgement when making decisions but must do so consistently with the grant of power, that is, to advance the interests of the company and its members as a whole. A misuse of that power might not only be a breach of duty but might amount to oppression or fraud on a power.
As directors are given power to advance the company’s interest, they must not use their position to advance their own interest, or to cause the company detriment.
This does not mean that a director cannot derive any benefit from their decisions. As most directors will also be shareholders, they will always derive some personal benefit from the success of the company. Provided the predominant purpose is not personal benefit, and the power is used in good faith in the interests of the company, directors will not breach the rule simply because they derive some benefit from it.
2. The duty to avoid conflicts.
Directors must ensure that their duty to the company does not conflict with their personal interests. One obvious example is where directors might obtain a personal financial advantage from dealing with the company, or where the company contracts with a company connected to a director.
As a fiduciary is bound to put the interests of the company above their own interests, it is important that directors do not permit the exercise of their power to be swayed (or appear to be swayed) by personal interests.
A director may still enter into an agreement with the company, or derive some personal benefit, but care should be taken, and a high level of disclosure and approval required before any such transaction is entertained.
3. The duty to not make profits or personal benefit.
Closely related to the obligation above, the law imposes a strict duty against fiduciaries obtaining a personal benefit from their office. It extends to a duty not to mix the company’s funds with others, and to benefit others in a way that does not properly advance the interests of the company.
Again, this can generally be addressed by full and proper disclosure and authorisation for any related transactions.
4. The duty to keep confidential information confidential.
This duty to use the company’s information solely for the purposes of the company is related to the foregoing duties. Information obtained during your directorship belongs to the company, as do any opportunities that arise therefrom. Misuse of that information can be a breach of duty.
5. The duty to keep and exercise discretion.
While directors have power to delegate some responsibilities, they must ensure they do not abrogate their responsibilities to others or fail to take steps necessary for the good governance of the company. While some duties may be delegable, the essential duties of the role, and responsibility for the exercise of those functions, are not.
The appointment as a director is a personal one and cannot simply be assigned.
6. The duty to exercise due care and diligence in the performance of functions.
Directors owe companies a duty to bring all their skills, experience, knowledge, and abilities to the running of the business. This duty does not mean that you cannot have other interests or involvements, nor does it mean – especially for non-executive directors – that you must give the company 100% of your attention 100% of the time.
The standard is that of an ordinary prudent person in the position of the director acting on their own behalf. It includes the duty to be informed as to the affairs of the company, to exercise independent judgment as to the interests of the company, and to guide the company acting in its best interests.
The Corporations Act has incorporated many of the common law duties so that directors now also have the following duties under legislation:
- The duty to act in good faith in the best interests of the corporation and for a proper purpose;
- The duty not to make improper use of position and information;
- The duty to exercise the degree of care and diligence that a reasonable person would exercise in similar circumstances.
Another important duty for any director arising out of the Corporations Act is:
- The duty to prevent the company from trading whilst insolvent
If a director has reasonable grounds to suspect a company is, or is about to be, insolvent (i.e. unable to pay its debts and as when they fall due) they have a positive duty to promptly ensure the company either:
- reaches an accommodation with creditors so that the threat of insolvency is removed,
- obtains sufficient financial support for the company to remove the threat of insolvency,
- ceases trading, and/or
- calls in external controllers before incurring any further debt.
Should a director be unable to do these things, the appropriate response is to immediately resign their office, however, that may not remove liability.
Current practice is that once a director forms a reasonably based view that the company is or maybe about to become insolvent, they should act promptly to secure pre-insolvency advice by consulting with appropriate professionals – lawyers, accountants, and insolvency practitioners – and then comply with that advice. This might involve administration, liquidation, or negotiation with creditors.
The law imposes personal liabilities on directors for many breaches of duty and companies are entitled to take action against directors for such breaches. In addition, civil penalties can be imposed for most of the duties discussed above (and some more specific matters outside the scope of this general advice). Nonetheless, the Corporations Act provides limited protection for directors who have acted promptly, sought proper advice, reasonably relied on the advice of others in the performance of their functions, and for those who have disclosed personal interests or conflicts.
Liability for Debts
Directors should also take note that while most company debts remain solely with the company, certain company debts might be transferred to directors. This typically arises in two ways:
- Directors have provided personal guarantees for the performance of the company’s obligations. Examples where this can happen include finance, leases, and trade credit accounts, or
- Tax liabilities – outstanding company GST, PAYG, and SGC can all be levied against directors by the ATO issuing a director penalty notice.
The office of director is an important one and comes with important duties. Directors should remember a company is a separate entity to themselves and that they must while acting as a director, but the interests of the company first.
If they act prudently and use their position in good faith to benefit the company and ensure they disclose potential conflict, directors need not be overly concerned with breaching their obligations.
NB: It is impossible to enumerate every possible situation in which a director might find themselves and give advice relevant to each. Accordingly, general advice on the breadth and nature of duties is provided. Compliance with these governing principles should ensure compliance with your obligations. Should more specific advice on a specific area be required, we would be happy to provide more focused assistance.
If you require assistance in relation to any of the information provided above, HHG Legal Group’s lawyers can provide advice to you and your business to minimise your future risk. Contact us today by emailing Murray Thornhill on firstname.lastname@example.org or Blair Campbell on email@example.com or calling us on (08) 9322 1966.