Company Directors Duties

18 February 2022 in Business Law | 7 min read | skip to FAQs

This article discusses the duties and obligations of a company director. A director is an officer of a company and has duties and powers in relation to the management of the company, these are set out in the Corporations Act 2001 (Cth)  and may be further defined in the company’s constitution. The definition of a director is provided in section 9AC of the Corporations Act 2001 (Cth).

The relationship between a director and a company is fiduciary in nature, meaning that when a director is making decisions on behalf of the company, the director must have regard to the interests of the company and place the company’s interests ahead of the director’s interests.

The primary governing legislation concerning directors and shareholders in a company is the Corporations Act 2001 (Cth). This legislation contains over 1,700 different sections and is very comprehensive and detailed. As a result of this it can be confusing for any director seeking guidance. The business lawyers at BSM Sydney Lawyers have decades of experience and are able to provide this guidance.

Directors Duties

Directors’ duties are set out in the Corporations Act 2001 (Cth) (Act) starting at section 180 and appear throughout the Corporations Act 2001 (Cth). The primary statutory duties are summarised below.

Civil Offences

Duty to Act with Care and Diligence

A director or other officer of a corporation, such as a senior manager, have a duty to exercise care and diligence when exercising their powers and managing companies. Put simply, the level of care and diligence expected of directors is that of a reasonable person in the position of the director of the company in the company’s circumstances. This definition allows for context appropriate standards to be applied to a director.

The duty to exercise care and diligence may encompass things such as a director being aware of a company’s financial position, properly protecting the company’s interests, avoiding breaches of the law, and attending meetings.

Duty to Act in Good Faith

Directors must exercise their power and discharge their duties in good faith in the best interests of the corporation, and for a proper purpose. (Section 181 of the Act). The best interests of the company are to be considered as the interests of the company’s shareholders collectively. Generally, this duty is not owed to particular shareholders and directors may act in a way that serves the long rather than short term interest of a company. The best interests of a company can alter when it is faced with financial difficulties or is insolvent. When this is the case directors must act in good faith and in the best interests of the company’s creditors.

Duty to not Improperly Use Position

A director, secretary, other officer, or employee of a corporation must not improperly use their position to gain an advantage for themselves or someone else; or cause detriment to the corporation. (Section 182 of the Act). For example, a director may have the power to issue shares in a company. When exercising these powers directors must do so for a proper purpose.

Duty to not Improperly Use Information

A person who obtains information because they are, or have been, a director of a corporation must not improperly use the information to gain an advantage for themselves or someone else; or cause detriment to the corporation. (Section 183 of the Act).

Duty to Avoid Insolvent Trading

A company is insolvent if it is in circumstances where the company can no longer pay its debts as and when the debts fall due (Section 95A of the Act). Accordingly, insolvent trading occurs where a company incurs debts even though the company is insolvent.

Directors have a legislative duty to prevent insolvent trading. Directors can prevent insolvent trading by paying appropriate attention to a company’s financial position. Put simply, directors will be in breach of their duty to prevent insolvent trading where “there are reasonable grounds for suspecting the company to be insolvent, or would so become insolvent” (section 588G Corporations Act 2001 (Cth).

This applies if:

1. A person is a director of a company at the time when the company incurs a debt; and b) the company is insolvent at that time or becomes insolvent by incurring the debt, or by incurring debts including that debt, and c) at that time there are reasonable grounds for suspecting that the company is insolvent or would become insolvent, as the case may be; and d) the time is at or after the commencement of this Act.

2. By failing to prevent the company from incurring the debt the person contravenes this section if: a) the person is aware at the time that there are such grounds for suspecting; or b) a reasonable person in a like position in a company in the company’s circumstances would be so aware.

It is important to note that this section is a civil liability provision pursuant to section 1317E of the Act and if a director contravenes this section, they may be personally liable for any debt incurred by the company.

Potential Defences to Insolvent Trading.

There are four key potential defences for directors accused of being responsible for insolvent trading. These defences are available where:

1.       The director proves that they had reasonable grounds to expect that the company was solvent
2.       The director reasonably relied on information about the solvency of the company by competent and reliable person who was responsible for providing information about the company’s solvency.
3.       The director was absent from managing the company due to ‘illness or some other good reason’
4.       The director took ‘all reasonable steps to prevent the company from incurring the debt or making the disposition of its property’.

Duty to Prevent Creditor Defeating Disposition

This is found in Section 588GAB of the Act. This section is related to insolvent trading and may be briefly summarised as a director must not transfer funds or assets from the company if such transfer would result in a creditor being unpaid.

Directors have a duty not to prejudice the interests of creditors. When a company is experiencing financial difficulties or facing insolvency, a director’s duty to act in the best interests of creditors supersedes their duty to act in the best interests of the company and its shareholders.

According to the Act, a director must not engage in conduct that results in the company making a creditor defeating disposition of property of the company if: a) the company is insolvent; or b) the company becomes insolvent because of the disposition or a number of dispositions made at the time of the disposition; or c) less than 12 months after the disposition, the start of an external administration of the company occurs as a direct or indirect result of the disposition; or d) less than 12 months after the disposition the company ceases to carry on business altogether as a direct or indirect result of the disposition.

The duty to not prejudice creditors also arises in contexts where companies in a corporate group enter a transaction. For example, where a director engages in illegal phoenix activity, they are in breach of their duty not to prejudice creditor interests. In general terms, Illegal phoenix activity occurs when an existing company is abandoned and its assets are transferred to a new company in order to avoid paying creditors, taxes and employee entitlements. For further information see our article on illegal phoenix activity.

Criminal Offences

This is found in Section 184 of the Act and relates to Good Faith, Use of Position and Use of Information

1. A director commits an offence if they are a) reckless; or b) dishonest; and fail to exercise their powers and discharge their duties: c) in good faith in the best interests of the corporation; or d) for a proper purpose.
2. A director commits an offence if they use their position dishonestly: a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation.
3. A person who obtains information because they are, or have been, a director of a corporation commits an offence if they use the information dishonestly: a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation.

Penalties for Breach of Duty

It is important that the above duties are complied with in their entirety, as penalties and compensation may apply if directors’ duties are found to have been breached. Breaching directors’ duties can attract serious criminal and civil penalties, including fines, disqualifications, and imprisonment. The gravity of these penalties highlights the importance of seeking legal advice when faced with a legal issue relating to director duties. The business lawyers at BSM Lawyer Sydney can provide this advice.

If a breach is found to have occurred regarding a directors’ civil (as compared to criminal) obligation, the following civil penalties may apply per section 1317E of the Corporations Act 2001 (Cth):

1.Pecuniary penalties (fines) which are contained in section 1317G of the Corporations Act 2001 (Cth); and/or

2.Disqualification from managing corporations which is contained in s 206C of the Corporations Act 2001 (Cth); and/or

3.Compensation orders, where it is found that the corporation has suffered a damage or loss resulting from the breach, a director may be ordered to compensate the corporation for the loss incurred as set out in section 1317H of the Corporations Act 2001 (Cth)

If it is found that a director has committed a criminal offence, which requires that the additional elements of recklessness or dishonesty can be proved beyond reasonable doubt, the following criminal penalties may apply in accordance with Schedule 3 of the Corporations Act 2001 (Cth):

1.Fines determined by the Court, based on the severity of the breach; and/or

2.Imprisonment for up to five (5) years.

 

How can BSM Sydney Lawyers assist you?

This article is a summary of the duties and obligations of directors under the Corporations Act 2001 (Cth). However, the duties and statutory obligations associated with the position of director of a corporation, is an extensive and complex area of commercial law which often requires legal advice on a case-by-case basis. Our highly experienced business lawyers have over 35 years of experience and offer tailored advice to ensure compliance with legal requirements thus minimising the risk of contraventions of directors’ duties.

If you are the director of a company and are seeking advice on your obligations under the Corporations Act 2001 (Cth), contact the senior business lawyers at BSM Sydney Lawyer for a free 20-minute consultation.

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