What are the three important legal duties of a director?

Each board director of an Australian company owes duties to the company established by statute and at common law. With a fiduciary relationship existing between a director and the company, there is an overriding responsibility to act in the company’s best interest. Thus, the legal duties imposed by the Corporations Act 2001 and at common law aims to protect the company. In addition, it ensures that directors satisfy high standards of good faith and loyalty to the company.

Section 9 of the Corporations Act defines the term “director”. Here, it is broadly defined to include persons who may not be validly appointed as a director, but act as ‘de facto’ or ‘shadow’ directors. 

Four Primary Duties

Both statute and common law have developed the legal obligations imposed upon board directors. Specifically, the Corporation Act specifies four main duties for directors, which similarly exist at common law: 

1. Exercise powers with reasonable care and diligence 

Imposes an obligation on the director to act with the degree of care and diligence that a reasonable person would exercise if in that role. Fulfilling this duty involves keeping informed about the companies activities and appropriately guiding and monitoring the company’s activities. Additionally, a director should attend and be attentive at board meetings unless exceptional circumstances prevent otherwise. 

2. Act in good faith 

This duty requires a director to act in good faith in the best interest of the company and for a proper purpose. Common law considers this duty a fiduciary duty. Indeed, to act in good faith includes avoiding conflicts of interest and to properly manage conflicts if they arise. A director will breach this duty if they fail to give proper consideration to the separate interests of the company ahead of other interests. A director must take into account the interests of the company’s shareholders. 

3. Not to improperly use position 

Directors must not improperly use their position to gain an advantage for themselves or to the detriment of the company. For example, a director should not apply the company’s property either; for their own personal benefit, or for the benefit of any other person without the company’s authority. 

4. Not to improperly use information 

Similar to the above duty. Directors must not improperly use the information gained in the course of their position as board directors to gain a personal advantage or to cause a detriment to the company. They must not make unauthorised use of confidential information belonging to the company. 

Other Statutory Duties 

In addition to the four basic duties, there are other legal duties that the Corporations Act imposes.

Insolvent Trading

Directors have a duty to prevent insolvent trading:

• when the company is insolvent; or 
• when, by incurring the debt, the company becomes insolvent; and 
• there are reasonable grounds for suspecting, at the time of incurring the debt, that the company is insolvent or will become insolvent. 

Specific provisions under the Corporations Act allow for a director to become personally liable to the company or to a third party creditor for the amount of the debt and any loss or damage suffered by the creditor in relation to the debt because of the company’s insolvency. Furthermore, the nature of the duty to prevent insolvent trading is discussed in great detail in our previous article.

Keeping of Financial Records 

Directors are expected to take reasonable steps to ensure that a company complies with its obligations regarding the adequate keeping of financial records and financial reporting. 

Disclosing Interests 

Under the statue, directors should also disclose matters relating to the affairs of the company in which he/she has a personal interest. Consequently, this imposed responsibility helps ensure the director is acting in good faith as the overriding duty of the fiduciary relationship is to act in the interest of the company. 

Consequences of Breaching Directors’ Duties 

If a board director breaches one of their legal obligations, they can be liable under Australian law. The legal consequences can vary depending upon the severity of the breach and the particular duty breached.

A director in breach can be subject to significant criminal or civil liabilities, or liability to pay compensation for the loss and damages incurred due to their breach. Directors are typically only exposed to criminal sanctions when the breach has been committed with intentional dishonesty. Under the corporations act, a director may even be disqualified from managing companies for a period of time. There can also be commercial consequences. 

Proceedings can be brought against a breaching director either by: 

• the company; 
• shareholders under the statutory derivative action provisions 
• regulators such as ASIC or the ACCC 
• third parties for misleading and deceptive conduct or anti-competitive behaviour; or
• creditors.  

Summary 

Both statute and common law imposes various legal obligations upon a board director that are considered to be significant legal responsibilities. Designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company. 

With the relationship between a board director and a company being one of fiduciary, it is imperative that a director acts in good faith and does not engage in any activity that could be to the detriment of the company. Indeed, there can be severe legal consequences when breaching a director’s duty, so it is important if you are a director to be aware of your duties both at common law and statute. 

What are the different types of directors?

There are two types of directors: formal and informal. Formal directors are appointed and include executive, non-executive, alternate and nominee directors. Informal directors are not appointed but have significant influence in controlling the company and include de-facto and shadow directors. Our discussion will be dealing with formal directors – however, there are avenues for ASIC to also hold informal directors to account.

What are the 4 key directors duties?

Overarching the common law and statutory duties, the role of a company director is to govern a company on behalf of the shareholders or members of that company.
The laws found in the Corporations Act 2001 (Cth) are designed to reflect the common law standard of director duties. Importantly, the provisions aim to promote good governance and limit conflicts of interest between directors and their companies. Importantly, it aims to prevent directors from taking advantage of their position in order to advance their own interests over the interests of the company.
There are four main duties found in the Corporations Act:

1. Duty to act with reasonable care, skill and diligence (including the duty to prevent insolvent trading). Under s180, this duty requires a director to act with a degree of care and diligence that a reasonable person might be expected to show in the role. Common law places great weight on this duty with respect to approval of financial statements [Centro, 2011] and statements issued by a company [James Hardie, 2012]. Further, risky transactions without the prospect of producing a benefit, or failure to inform board members of significant issues can create a breach of this duty. The extent of this duty is dependent on a range of circumstances. These include the type of organisation, the size and nature of the business and the composition of the board [ASIC v Rich, 2009]. Also, if a particular director holds out to possess certain expertise to obtain the directorship, the director’s exercise of care and diligence will be assessed against that expertise. For example, if a director holds out that she has specialised financial knowledge and she occupies a financial role, her accountability for the organisation’s finances will be higher compared with an ordinary director [ASIC v Adler, 2002]. Moreover, non-executive directors still have a duty to acquire at least a rudimentary understanding of the business of their organisation. Even if it is practice for a non-executive director to be unaware of the organisation’s circumstances, the position of a director comes with the responsibility of a core irreducible standard [Daniels v Anderson, 1995]. There is, however, the business judgment rule which could protect a director in relation to a claim for breach of this duty. This essentially requires directors to make a judgment that they rationally believe is in the best interests of the organisation. A judgment is considered to be rational unless no reasonable person in the director’s position would consider it rational.
2. Duty to act in good faith in the best interests of the organisation and for a proper purpose is a two-part rule. The rule requires a director under section 180(1), to act honestly, fairly and loyally in furthering the interests of their organisation. This means that you have to place the interests of the organisation above your own when making decisions.  Directors are also required to act for ‘proper purposes’, meaning that decisions are made for the purpose of benefiting the organisation. To determine if one has breached this duty, it is important to ask whether the director subjectively believed that what they did was in the best interest of the company. If the answer is ‘yes’, then the next question is whether the belief was so unreasonable that no reasonable board of directors would have made the same decision. If the answer is again ‘yes’ then it is likely that a director may have breached this duty.
3. Duty not to improperly use information or position. Section 183 requires directors to use the information they gain in their role as director to benefit the organisation rather than themselves. Directors are in a position of power and authority and have access to confidential information. As such, if a director uses the information they gain in their role for personal advantage or to cause detriment to the organisation then the director may be liable for breaching this rule.
4. Duty to disclose and manage conflicts of interest. It is not uncommon for directors to encounter situations where a conflict of interest may arise. Whilst directors have a duty to avoid conflicts of interests having a conflict of interest is not necessarily a breach of this duty. As such in these situations, under section 191 directors must notify other directors of their personal interest when a conflict arises. Further, you must avoid taking part in board decisions that relate to your conflict of interest. This is to ensure that directors are placing their organisation ahead of themselves.

How can Snedden Hall & Gallop assist?

If you are the director of a company, understanding the duties that position entails are important. Dennis Martin can assist you in understanding the roles of directors and provides assistance if you are concerned that you may have breached a directors duty. You can contact him for any commercial matter on (02) 6285 8000 or by email.

Further reading

This is the first in a three-part blog series. Have a look at part 2: a historical overview and part 3: issues facing the officers of an association.