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PRBL 004

Commercial and Corporate Law for


Managers
Weeks 1- 6: Corporate Law
Lecture 4
Directors Duties

Directors Duties
General law / statutory duties of:
Good faith and loyalty
Care, skill and diligence

The director as a fiduciary


Equity sets high standard of loyalty for directors because of their
fiduciary relationship to company
Standard of loyalty is reflected in the positive and negative
obligations of co. directors.
Positive obligations include the duties:
(1) to act in good faith in cos best interests
(2) to act for proper corporate purposes
(3) to give adequate consideration to matters being
decided, and not to fetter their discretion
Negative obligations require directors to avoid various
kinds of conflicts of interest (e.g. improper use of
information, abuse of position, and insider trading)

Directors duties
Why does the law impose them?
recognition that directors interests may diverge from those of
shareholders (eg, excessive salary packages and perks)
Shareholders are vulnerable to:
(a) fraud eg, director using cos assets, opportunities or info to
advance their personal interests
(b) mismanagement eg, director risking loss or devaluation of
cos assets through incompetence and poor judgement
Mainly to ensure loyalty of directors to co
Director is in a fiduciary relationship with co (ie, not at arms length)
A fine balancing act directors must be made accountable to cos
interests while they must also have sufficient discretion to take
decisions that carries some risks

Fiduciary duties of directors What and


Why?
Fiduciary relationship exists where a person holds a
position of trust in relation to another person who, due to
the circumstances, is vulnerable to misuse of power by the
fiduciary.
Duties are owed to:
(1) company as a whole Percival v Wright (ie,
collective body of shareholders)
(2) in some instances can be to individual
shareholders Brunninghausen v Glavanics;
Coleman v Myers (L & H p 304)
(3) Creditors (but not directly) eg, Kinsela v Russell
Kinsela Pty Ltd

Fiduciary duties (cont)


Who must perform the duties?
Directors, secretaries, other officers and employees of
co. s 179(1)
s9 definition (remember from Week 3):
Officer any person who makes decision affecting
corporations business or on whose instructions the
board is accustomed to act
Director can be appointed director, alternate
director, de facto or shadow director

What are the duties?


Broadly there are 2 categories of duties:
1. Loyalty and Good Faith
2. Care, Skill and Diligence
Where do the duties come from in law?
1. General law (common law and equity)
2. Part 2D.1 of CA

1. Duties of loyalty and good faith (outline)


Directors, as fiduciaries, must show special qualities of good
faith, fairness and loyalty when acting
1.Duty to act in good faith in the interests of co as a
whole
2.Duty to exercise ones powers for proper purposes
(e.g. not collateral ones); and
3.Duty to avoid conflicts between ones personal
interests and those of co.

2. Duties of care, skill and diligence (outline)


This second group of duties owed by directors are those of
care, skill and diligence
Concerned with whether sufficient care extended in
management of the company
1.Duty to exercise reasonable care, skill and diligence
when acting as director; and
2.Duty to prevent insolvent trading by co.

Duties of loyalty and good faith


1.

Duty to act in good faith in the best interests of the


company as a whole
Sources:
General law- fiduciary law
S181 (1) (a) : in good faith in the best interest of the
corporation
S 184 makes it a criminal offence if reckless or
intentionally dishonest

Duties of loyalty and good faith


1. Duty to act in good faith in the best interests of the company as a
whole
Description:
Has the director acted dishonestly or in a manner so extraneous to the
reasonable purposes of the company that their conduct is incapable of
being seen as promoting the interests of the company?
Duty requires to act bona fide in what they consider not what the
court may consider is in the interests of the company:
Re Smith & Fawcett Ltd [1942] per Lord Greene MR
Must be more than an mere honest belief- there is an objective element
and it is breached if the director acts in a way that no reasonable
director would have considered it to be in the best interests of the
company
ASIC v Adler [2002] NSWSC 171

Duties of loyalty and good faith


1. Duty to act in good faith in the best interests of the company as a
whole
What is the meaning of the interests of the company?
The collective (general body) of shareholders
- Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286
Individual shareholders?
Generally no (Percival v Wright [1902] 2 Ch 421) but there may
be exceptions: Brunninghausen v Glavanics (1999) 17 ACLC
1247 (director in direct and close contact with member so that the
director caused member to act in a detrimental way)
Creditors?
When nearing insolvent or when insolvent
Employees?
General rule No, not at the expense of interests of co
shareholders. But payment of employees might be in best interest to
retain good industrial relations
Parke v Daily News Ltd (1962) Ch 927 (L&H 309)

Duties of loyalty and good faith


1. Duty to act in good faith in the best interests of
the company as a whole
Corporate groups: see s 187
a director of a wholly owned subsidiary is taken to act in
good faith in the best interest of the sub company if:
the director acts in good faith in the best interest of
the holding company; and
subsidiary is not insolvent

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes
Statutory duty found in:
Section 181 (1) (b)
(1)A director or other officer of a corporation must exercise their powers and
discharge their duties
(b) for a proper purpose

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes

directors who purport to act with reference to the powers


granted to them, (RRs or the companys constitution) will
be in breach of the duty where the purpose or objective
giving rise to the exercise of the power is not one
reasonably contemplated by the RR or constitution

Court looks at 2 things (2 stage process):


1. the objective purpose for which the power was
granted and
2. the purpose which actually motivated the exercise
of the power

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes
Applications of the duty to act for proper purposes
Improper exercise of power to issue shares is common
example of breach
The power to allot shares under s 124(1)(a) is a highly
contentious one. (see s 198A, dirs may exercise power)
Usually arises when theres hostile takeover or battle
for cos control by existing shareholders.
Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC
821: If directors issue shares to create or destroy voting
power of majority shareholders, the duty will be
breached.

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes
Mixed purposes - the but for test
Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR
285 High Court: Where there is more than one purpose
for a share issue the but for test should be applied to
work out whether directors breached their duty and
issued shares for an improper purpose
Regardless of whether the impermissible purpose was
the dominant one or but one of a number of significantly
contributing causes, the allotment will be invalidated if the
impermissible purpose was causative in the sense that, but
for its presence, the power would not have been
exercised.
Per Mason CJ, Deane and Dawson JJ in Whitehouse

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes
An allocation of shares may be invalid if:
aimed at transferring control of a major co. asset:
Bailey v Mandala Private Hospital (1988)
dominant purpose to preserve the position of exiting majority
members: Ngurli Ltd v McCann (1953);
purpose to make rights of existing members valueless, and
theres no apparent benefit to co: Kotokovich Constructions
Pty Ltd v Wallington (1995) diluting and devaluing the others
share in the business.
where cos assets are given away to a family co without any
consideration: Bishopsgate Investment Management Ltd (in
liq) v Maxwell (1993)

Duties of loyalty and good faith


2. Duty to exercise powers for proper purposes
Other examples of breach of duty to act for proper purposes:
Directors improper refusal to register a transfer of
shares

Exercise of management powers for improper purpose


use of company funds to promote re-election of directors

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : statutory position
S 182 reinforces general law (Regal Hastings v Gulliver) that a fiduciary
should not profit by virtue of that position
A director, secretary, other officer or employee
must not improperly use their position to
(a) gain an advantage for themselves or for someone else; or
(b) cause detriment to the corporation
S 183 Applies to directors or officers
A person who obtains information because they are or have been a
director or an employee of a corporation must not improperly use the
information to
(a) gain an advantage for themselves or someone else; or
(b) cause detriment to the corporation

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : statutory position
S 184 (2), (3) Applies to directors or officers
Criminal offence if use position/information dishonestly
(a) with the intention of directly or indirectly gaining an
advantage for themselves or someone else or causing
detriment to the company; or
(b) Recklessly as to whether the use may result in
themselves or someone else gaining an advantage or
causing detriment to the company

Duties of loyalty and good faith


Sections 182 and 183
vs
General law (fiduciary duties)
It is important to note that some provisions
codify the general law, but mostly the
sections supplement it
22

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
A fundamental rule of equity that a director must not allow a
conflict to arise between a directors personal interest
and duties owed to the directors company
Directors, being fiduciaries, are under a duty to avoid actual
or potential conflicts of interest
(Hospital Products Ltd v United States Surgical Corp)
Strict duty director liable even if he or she acts honestly
and does not stand to profit.
Cover situations where, although theres no clear conflict,
yet there is a real possibility of conflict
(Phipps v Boardman)

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
Note also:
Disclosure obligations include:
(a)requirements in ss 191-195, 205G (listed cos) and 200A
- 200J (retirement payments)
(b) Chapter 2E (related party transactions)
(c) Part 7.10, Div 3 (insider trading)

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the
company
Dealings with the company
Director may be in breach of duty by entering into a
contract with co.
Such breach can also occur where relationship is
indirect (i.e. where director is a director or member of
another co. which enters into the contract ) Transvaal
Lands Co v New Belgium (Transvaal) Land &
Development Co [1914] and State of South Australia v
Marcus Clark (1996)

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
Exception: if provide full disclosure to the company and obtain
shareholder approval (ratification)
Reduction of risk:
Risk of breaching duty to avoid conflicts of interest may be
reduced by :
(a) a provision in constitution authorising director to have an
interest in a contract with the co. Directors can thereby be
absolved from breach: Re Automotive & General
Industries Ltd [1975]; or
(b) interested director makes full and frank disclosure of their
interests in any contract with co. Furs Ltd v Tomkies
(1936) and Regal (Hastings) Ltd v Gulliver [1942]; and
(c) director abstains from taking part in deliberations or voting
on the matter: Jenkins v Enterprise Gold Mines NL.

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : general law

Not to derive personal profit from being a director


Since the opportunity exists for them to take advantage
of their privileged position, not only must they act in
good faith, they must be seen to act in good faith:
Regal (Hastings) Ltd v Gulliver [1942]
NOTE: This case might be decided differently today
because courts have discretion to excuse directors
and officers from liability if they have acted honestly:
ss 1318 and 1317S.

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : general law

Bribes or undisclosed benefits


Breach of duty if they accept bribes or secret commissions in
return for securing a certain course of action
Boston Deep Sea Fishing & Ice Co v Ansell (1888).
No need for co. to suffer any detriment for breach to occur

Misuse of company funds


Must use company funds for company business.
Must not mix cos funds with their own.
Paul A Davies (Aust) Pty Ltd (in liq) v P A Davies (1983):
directors partly financed a holiday resort in their own names.
When resort was sold, ct held that profit belonged to co.

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : general law

Taking up corporate opportunity

Breach of duty arises where directors take up opportunities that


belong to co. Cook v Deeks [1916].

Even if co cannot or will not take up an opportunity, director is


still precluded from doing so
Regal (Hastings) Ltd v Gulliver [1942]; Green v Bestobell
Industries Pty Ltd [1982];

Some cases suggest that a director may take up a corporate


opportunity where the company has rejected the proposal and
the director has been approached in a private capacity:
Peso Silver Mines v Cropper (1966)

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : general law

Misuse of confidential information


Directors must not use confidential information for their
own benefit
This duty continues (survives) after a directors leaves a
company (ie, still cannot use confidential info obtained as
director of former company: Facenda Chicken v Fowler
[1987] 1 Ch 117)

Duties of loyalty and good faith


3. Duty not to act in conflict of interest with the company
No Conflict Rule : statutory position

Disclosure requirements:
S 191 - a director of a company who has a material
personal interest in a mater that relates to the
affairs of the company must give the directors
notice of the interest.
If disclose then may vote on things related to the
interest and transactions can proceed
Financial benefits Ch 2E

Duties of care & skill


(1) Duty to exercise reasonable care, skill and diligence
when acting as director; and
(2) Duty to prevent insolvent trading by co.

Duties of care & skill


1. Duty of care, skill and diligence

Duty of care, skill and diligence arises under:


(1)executive directors contract of employment (cf. nonexecutive ones);
(2) general law (law of torts and equity) or
(3)s 180(1) of Corporations Act

Important to note the distinction with the first group of


duties - this is not a fiduciary category
The result of a successful claim under torts is damages,
not an end to a contract (rescission) or account of profits

Duties of care & skill


1. Duty of care, skill and diligence
S 180 (1) sets out:

A director or officer of a corporation 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 or officer of a corporation in the
corporations circumstances; and
occupied the office held by, and had the same
responsibilities within the corporation as, the director or
officer
Objective and reasonable test
General tort law principles apply to determine what the
standard or degree of care is

Duties of care & skill


1. Duty of care, skill and diligence
- General law v/s statutory duty under s 180(1)
Duties of care and under general law and s 180(1)
substantially the same

However they differ as follows:


(1) GL duties owed by directors and senior
executive officers, whereas under s 180(1) owed by
directors and officers;
(2) To prove breach of duty, under GL, there must be
evidence of (a) breach of duty; and (b) damage
sustained by co. Under s 180(1) evidence of breach
of duty is sufficient; and

Duties of care & skill


1. Duty of care, skill and diligence
- General law v/s statutory duty under s 180(1)
Duties of care and under general law and s 180(1)
substantially the same

However they differ as follows (contd):


(3) Consequences of breach:
Under GL, differences in measure of
compensation between common law damages
and equity (compensation or account of profits)
whereas under s 180(1): civil penalties if initiated
by ASIC (eg, pecuniary penalty / disqualification /
compensation)

Duties of care & skill


1.

Duty of care, skill and diligence scope of duty of care

Daniels v Anderson (1995) minimum standard of care for nonexecutive directors


NSW CA held that directors of listed public cos had to take
reasonable steps to place themselves in a position to guide
and monitor cos management. In particular:
directors must become familiar with cos business when they
join the board;
They must regularly review cos financial statements to be
aware of its financial situation;
Those appointed because of their special skills or experience in
one aspect of cos business must look at other aspects too;
They are allowed to make business judgments and take
commercial risks; and
They cannot shut their eyes to corporate misconduct and raise
ignorance as a defence.

Duties of care & skill


1.

Duty of care, skill and diligence scope of duty of care


Care
Director must take reasonable care in performance of
executive duties ASIC v Adler (2002)
Skill
Directors must possess certain basic skills in relation to
financial statements and affairs of co. Cth Bank v
Friedrich (1991)
Must comply with a core, irreducible requirement of skill
involving an objective test, such as ordinary competence
or reasonable ability : DCT v Clark (2003); ASIC v Vines
(2003)
Must exercise degree of skill expected of a director with
same level of knowledge, experience or expertise: Re
City Equitable Fire Insurance Co Ltd [1925]

Duties of care & skill


1.

Duty of care, skill and diligence scope of duty of care


Diligence
They must be able to monitor and guide cos
management:
Daniels v Anderson (1995)
Diligence includes:
(1)attendance at all board and committee meetings
(except illness and being interstate or abroad);
(2) basic understanding of cos business; and
(3) continued obligation to keep informed about and
monitor financial and general affairs of co: ASIC v
Adler (2002); ASIC v Rich (2003).

Duties of care & skill


1.

Duty of care, skill and diligence

Entrepreneurial risk taking

s 180(2) contains a business judgment rule to


protect directors from liability for decisions that were
bad but made in an honest, informed and rational
way and in cos interests.

If s 180(2) is fulfilled then the business judgement


cannot be reviewed by the courts

Duties of care & skill


1. Duty of care, skill and diligence
s 180(2) business judgment provision
(2) a director or other officer of a corporation who makes a
business judgement is taken to meet the requirements of [s 180
(1)] and their equivalent duties at common law and in equity if
they:
made the jment in good faith and for a proper purpose
do not have a material interest in the subject matter of the
jment
inform themselves about the subject matter of the jment to
the extent that they reasonably believe to be appropriate
Rationally believe that the jment is in the best interests of
the company
If this is made out then not liable under s 180 (1)
ONLY applies to s 180 or GL duty of care, skill and diligence

Duties of care & skill


1. Duty of care, skill and diligence
Business Judgment Rule

S 180 (3) defines what a business judgment is:

Means any decision to take or not to take action in


respect of a matter relevant to the business
operations of the corporation
Business operations do not include decisions made by
directors such as the power to issue shares or pay
dividends

Duties of care & skill


1.

Duty of care, skill and diligence

Ability of Director to rely on others

Section 189 may apply:


if in a court case (proceedings) about the director
possibly having breached a duty, the issue of whether it was
reasonable for a director to rely on another persons
information

Duties of care & skill


1. Duty of care, skill and diligence
Ability of Director to rely on others
Section 189 - reasonable if it was prepared:
by an employee of the company who the director believes on
reasonable grounds is reliable and competent;
a professional adviser or expert who the director believes
is giving advice within their expertise;
another director in relation to matters within that directors
authority
a committee of directors on which the directors did not serve
and in relation to matters within that committees authority
AND the reliance was made
in good faith ; and
after making an independent assessment of the information
having regard to the directors knowledge of the corporation
and the complexity of the corporation

Duties of care & skill


1. Duty of care, skill and diligence
Responsibility for delegates

s 198D allows directors to delegate their functions to


others in co., subject to any contrary provisions in cos
constitution.

s 190(1) makes directors responsible for actions of


their delegate/s.

s190(2) absolves directors from liability if they


believed that delegate would exercise power in conformity
with directors instructions, and they also believed : (1) on
reasonable grounds; and (2) in good faith; and (3)
after making proper inquiry if circumstances so
warranted, delegate was reliable and competent.

Duties of care & skill


2.

Directors duty to prevent insolvent trading

S 588G the requirements


if a person is a director of a company at a time when a
company incurs a debt
the company is insolvent at the time, or becomes insolvent
by incurring that debt
at the time there were reasonable grounds for suspecting
that the company was insolvent or would so become
insolvent
Subsection (2) then makes the person (director) liable if
the person was aware there were the grounds to suspect
insolvent (ie actual knowledge)
or a reasonable person in a like position in the companys
circumstances would have been aware (constructive
knowledge)
Subsection (3) makes it an offence to do all of the above if
there is an element of dishonesty

Duties of care & skill


2.

Directors duty to prevent insolvent trading

What is insolvent?
S 95A : a person is solvent if they are able to pay
their debts as and when they become payable;
Cash flow test (able to pay debts as and when they
fall due?);
Presumptions of insolvency: ss 588 E
Eg, if failed to keep adequate records under s 286
ASIC v Plymin [2003]

Consequences of breach
of duty

General law breaches of fiduciary duty

Equitable compensation or damages


- where breach of fiduciary duties
Account of profits
- where undisclosed profits from undisclosed conflicts
Rescission of contract
- where undisclosed interest in contract
Constructive trust
- where director misappropriates property or
misapplies money
Injunction

Consequences of breach of duty


Statutory breaches of duty (ss 180-183, s 588G)
Civil penalties
ASIC must make a declaration first: s 1317E (1)
ASIC asks for a pecuniary penalty order of up to
$200,000: s 1317G and/or
Disqualification order : s 206C (see Week 3)
Court may order the person contravening CA to
compensate the company for damage suffered : 1317H
ASIC usually applies but company can also be heard
on all matters except whether the actual declaration or
order can be made: s 1317J
Company can apply for compensation for contravention
of civil penalty: s 1317H, 1317 J (2)

Consequences of breach of duty


Criminal penalties under the Act
Note not in general law unless there is an offence under
criminal code or state law
Contravention of good faith (s 181), use of position (s182),
use of info. (183) may in certain circumstances be criminal
offence: s 184 (1)(3)
Ie with dishonesty and intent/recklessness
S 184 - may be imprisonment up to 5 years and/or $200,000
fine
S 206B(1) a person automatically disqualified if convicted of
criminal offence under s 184
NOTE s 184 does not apply to s 180 duty of care, skill and
diligence, 180 is a civil obligation only

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