Do Directors Really Know What Duties They Owe Under The Law?

It is amazing how many people in the security industry open businesses based on the idea ‘I can do it better’. While entrepreneurial spirit is a great thing, those same people often do not give a great deal of thought to the ramifications of taking on the position of director of a company.

Source of Directors’ Duties

Duties are imposed on directors through a number of sources, including:

• statute or legislation
• case law or court-made law
• the constitution of the company.

Statute or legislation refers largely to the Corporations Act 2001 (Commonwealth) (the Act) which is an Act of Parliament that sets out various legal provisions, including directors’ duties and penalties applicable if those duties are breached.

Case law (also known as common law) is law created by courts. Often such laws arise where there are gaps in the legislation/statute and when the courts are called upon to define how statute should be applied to particular cases.

The company constitution is the document which sets out various rules that apply in relation to the particular company. The provisions of a standard constitution are often adopted from legislative provisions.

Due to the substantive nature of the above matters, this article only explores those duties on directors which are imposed by legislation.

Who is a Director?

Section 9 of the Act defines a director of a company or other body as including:

• a person who is appointed to the position of director or alternate director regardless of the name that is given to his or her position, and
• most importantly and interestingly, a person who is not validly appointed as a director, but either:
• that person acts in the position of a director, or
• the directors of the company or body are accustomed to act in accordance with that person’s instructions or wishes.

Therefore, even the statutory definition of director means that people other than those who are clearly appointed as being one can still be viewed as owing the duties of directors under statute/legislation and case-made law.

Statutory or Legislative Duties Owed by Directors

1. Section 180 (1) – Duty of care and diligence and the business judgment rule

This section requires a director or other officer of a company to exercise his powers and discharge his duties with a degree of care and diligence that a reasonable person would exercise if they:

• were a director or officer of a corporation in that corporation’s circumstances, and
• occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

2. Section 180 (2) – The business judgment rule

This section states that a director or other officer of a corporation who makes a business judgment is taken to meet the requirements of section 180 (1) and his equivalent duties at common law and in equity in respect of a judgment if he:

• makes the judgment in good faith for a proper purpose, and
• does not have a material personal interest in the subject matter of the judgment, and
• informs himself about the subject matter of the judgment to the extent that he reasonably believes to be appropriate, and
• rationally believes that the judgment is in the best interests of the corporation.

A ‘business judgment’ is taken to be any decision (including to omit to do something) relating to the business operations of a corporation.

It is not sufficient for a director to simply deny being aware of the risks of having the company transact in certain ways without having carried out due diligence or informed himself of the risks of the transaction.

3. Section 181 – Duty of good faith

Section 181 (1) of the Act states that a director or other officer of a corporation must exercise his powers and discharge his duties:

• in good faith in the best interests of the corporation, and
• for a proper purpose.

A director might be found in breach of this provision even if he believes that he is acting honestly.

4. Section 182 – Duty not to make improper use of position

Section 182 (1) of the Act states that a director, secretary, other officer or employee of a corporation must not improperly use his position to:

• gain an advantage for himself or someone else, or
• cause detriment to the corporation.

A director can be found in breach of this duty even if he or another person does not in fact receive some form of benefit or cause some form of loss to the corporation if he is found to have conducted himself with the intention and purpose of obtaining the benefit or causing the detriment.

An example would be where a director uses information which he learned through his position in the corporation (and which was not public knowledge) to have the company engage in a transaction which benefitted himself or his family. A well-known example would be what is commonly referred to in the media as insider trading.

5. Section 183 – Duty not to make improper use of information

Section 183 (1) of the Act states that a person who obtains information because he is, or has been, a director or other officer or employee of a corporation must not improperly use the information to:

• gain an advantage for himself or for someone else, or
• cause detriment to the corporation.

Again, regardless of whether an advantage is obtained or a detriment is caused, a director or former director can still be found in breach of this duty if he has the intention and purpose of obtaining such an advantage or causing detriment. Again, insider trading would fall into this type of category.

6. Section 184 – Criminal offences

Directors can also become liable for criminal offences under the Act in certain circumstances. The penalties for criminal offences tend to be more severe and can involve imprisonment. The main penalties for criminal offences arise under section 184 of the Act. The following is a summary of the types of scenarios in which criminal liability can ensue.

• Where a director is reckless or intentionally dishonest and fails to exercise his powers and discharge his duties:
• in good faith in the best interests of the corporation, or
• for a proper purpose.
• Where a director uses his position dishonestly:
  • with the intention of:
  • gaining an advantage for himself or someone else, or
  • causing detriment to the corporation, or
  • recklessly as to whether the use may result in him or someone else:
  • gaining an advantage, or
  • causing a detriment to the corporation.
• Where a person obtains information because he is or had been a director or other officer or employee of a corporation if he uses that information dishonestly:
  • with the intention of:
  • gaining an advantage for himself or someone else, or
  • causing detriment to the corporation, or
  • recklessly as to whether the use may result in:
  • him or someone else gaining an advantage, or
  • causing detriment to the corporation.

7. Section 588G – Duty not to trade whilst insolvent

Section 588G of the Act also imposes a duty on a director to avoid the corporation trading whilst insolvent. A corporation is deemed to be insolvent when it is unable to pay its debts as and when they fall due and payable.

A director will be in breach of this duty if:

• he is or was a director of the corporation at the time it incurred a debt, and
• the corporation was insolvent at that time or becomes insolvent by incurring that debt, and
• at the time of incurring the debt, there were reasonable grounds for suspecting that the company was insolvent or would become insolvent as a result of incurring the debt.

However, the following defences are open to such a director:

• where it can be proved that, at the time that the debt was incurred, that the person had reasonable grounds to expect, and did expect, that the company could pay its debts as they fell due and became payable and that it would remain in that position even if it incurred the debt.
• where the person, at the time that the debt was incurred had reasonable grounds to believe and did in fact believe that:
• a competent and reliable person was responsible for providing adequate information about whether the company was solvent, and
• that other person was fulfilling that responsibility, and
• on the basis of the information provided that the company was solvent at the time and would remain solvent upon incurring that debt and any other debts at that time.
• in the case of a director, where at the time that the debt was incurred by the corporation, that director did not take part in the management of the company because of illness or for some other good reason.
• if the director took all reasonable steps to prevent the corporation from incurring the debt.

So, in summary, becoming a director of a company has many implications. For that reason, it is imperative that anyone taking on this role is aware of those duties and responsibilities so that he at least has the knowledge to hopefully avoid situations that may lead to a breach of any of those duties.