Director’s Duties – A Refresher

We aim to deliver Just, Redemptive Outcomes®

These duties arise through the Corporations Act and the general law, and apply because of the fiduciary relationship between the Director and the Company (which demands a high standard of loyalty from the Director to the Company).

The duties owed by a Director include:

  • the duty to act in good faith in the best interests of the company;
  • the duty to not fetter discretions; and
  • the duty to act with reasonable care and diligence.

Where the duties are replicated in the Corporations Act, they are offence provisions, and can be the subject of prosecution where there has been a breach.

However, of greater significance is the possibility of civil liability for breaches of Director Duties (as the criminal offences are more difficult to prove than the civil liability).

1. Duty to act in good faith in the best interests of the Company

This duty requires a Director to put the interests of the company ahead of their own personal interests, and to actively consider what the interests of the company are when making decisions.

2. The duty to not fetter discretions

This duty will require the directors to give adequate consideration to all of the issues prior to making a decision.  They must independently assess the circumstances, and reach a decision of their own making (without relying on other persons).

That is, the decision must be each Director’s own decision, made without interference.  They will each be responsible for the decision they make.

3. The duty to act with reasonable care and diligence

The Directors, in making their decision, must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise in their position.

The test is an objective test in the sense that the question is what an ordinary person, with the knowledge and experience of the Director, might be expected to have done in the circumstances (Australian Securities Commission v Gallagher (1993) 11 WAR 105.

4. Consequences of breaching a Duty

Firstly, a breach of a statutory duty can result in criminal prosecution.  However, generally these prosecutions are difficult to prove.

If a Directors breaches his/her duty, and that breach causes loss to the company, the Directors in breach will be jointly and severally liable to compensate the company for that loss.

The test to prove this causation will be whether the loss would have occurred if there had been no breach of duty.

5. Related Party Transactions

The Corporations Act provides a number of Related Party rules.  These rules only apply to public companies.  Any company that is limited by guarantee is a public company.

The provisions are designed to protect the interests of a public company’s members as a whole, by requiring member approval before a company gives a financial benefit to a Related Party.

A Related Party is defined in section 228 of the Act, and includes (but is not limited to) the following persons:

  • The directors of a public company;
  • The directors of an entity that controls a public company;
  • Any spouses or de-facto’s of the directors; and
  • Parents or children of a director.

‘Financial benefit’ is not specifically defined in the Act.  However, the term must be given a broad definition.  The Act provides a number of examples of giving a financial benefit, including:

  • Giving a Related Party finance or property;
  • Buying an asset from a Related Party, or selling an asset to a Related Party;
  • Leasing an asset from a Related Party;
  • Supplying services to a Related Party, or receiving services from a Related Party;
  • Issuing security, or granting an option, to a Related Party; and
  • Taking up an obligation from a Related Party, or releasing a Related Party from an obligation.

As can be seen, the application of ‘giving a financial benefit’ is wide, and will involve a large range of circumstances.

If a Public Company is giving a financial benefit to a Related Party, it needs to obtain member approval before giving the financial benefit, and must give the financial benefit to the Related Party within 15 months of obtaining the approval.

In obtaining the member’s approval, there is a complex process of arranging for a member’s meeting, and providing the members with an explanatory statement and any other material documents to assist a member in deciding how to vote.

There are a number of “common sense” exceptions to the rule, including:

  • Where the terms of the financial benefit are reasonable in the circumstances and the parties are dealing at arms length;
  • Providing reasonable remuneration to an officer or employee;
  • Providing reasonable reimbursement of expenses;
  • Indemnifying an officer of the company in respect of a liability they incur because of their position (provided the liability does not fall within section 199A of the Act, which relates to breaches of the Act);
  • Small payments to Directors of their spouses (being less then $2000 in total);
  • Benefits to or by closely-held subsidiaries; or
  • The benefit is given to a related party in their capacity as a member of the company, and giving the benefit does not discriminate unfairly against other members of the company.

If an exception does not apply, and member approval is not obtained, the person or persons involved in the contravention commit a civil penalty infringement, which can result in a significant debt being payable to ASIC.

An extract from a paper given by Alistair Macpherson to the Australian Christian Churches Business Managers Forum in April 2010