Directors Duties

18 February 2022 in Business Law, Civil and Commercial Litigation and Law

A director is an officer of a company that has responsibilities, powers, and legal obligations in relation to the management of the company; a company may have several directors. A director must be above the age of 18 and must not have been disqualified from managing companies (unless they have legal permission to do so).

In Australia, company directors have certain fiduciary duties and legal duties when managing a company. These duties form a foundational aspect of corporate governance in Australia.

Fiduciary duties are duties that arise from relationships of trust and confidence between people whereas legal duties are outlined in legislation and derived from the common law.

Some key legal and fiduciary duties held by directors are:

Duty to Act in Good faith and in the Best Interest of the Company

Directors have a duty to act in good faith and in the best interest of the company. 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 Exercise Powers for Proper Purposes

Directors have various powers in relation to the management of a company.  A director’s powers may be established within legislation or a company’s constitution. 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 Retain Discretion

Directors have a duty to retain their discretion when managing a company. It is this discretion afforded to directors which enables them to act in the best interests of the company. Basically, this means that directors must not be influenced by third parties when making decisions in relation to a company. For example, a director would be in breach of their duty to retain discretion where they vote based on the instructions of a third party at a company meeting.

Duty to Avoid Conflicts of Interest

Directors have a duty to avoid conflicts of interest.  In simple terms, conflicts of interest occur where a director has a personal interest which conflicts with the interests of the company.

Directors must disclose the interests they hold in a transaction with their company in order to avoid breaching their duty to avoid conflicts of interests.  Conflicts of interest for directors commonly arise in instances such as where a director is personally profiting from their position, where a director is improperly using their position to gain a personal advantage or where a director has received a bribe.

Duty to Exercise Care and Diligence

Directors 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 in relation to this duty.

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 Prevent Insolvent Trading

A company is insolvent if it is in circumstances where the company can no longer pay its debts as and when they become payable. 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.  Directors will be in breach of their duty to prevent insolvent trading only where “there are reasonable grounds for suspecting the company to be insolvent, or would so become insolvent” (section 588G Corporations Act 2001 (Cth)).

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

•       The director proves that they had reasonable grounds to expect that the company was solvent
•       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.
•       The director was absent from managing the company due to “illness or some other good reason”
•       The director took “all reasonable steps to prevent the company from incurring the debt or making the disposition of its property”

The exhaustive requirements for these defences can be found in section 588H of the Corporations Act 2001 (Cth).

Duty not to Prejudice Creditor Interests

Directors have a duty not to prejudice the interests of creditors. This duty arises in contexts where a company is facing financial difficulties or potential insolvency. In these circumstances, 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.

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.

Penalties for Breach of Director Duties

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 Brander Smith McKnight are highly experienced in all facets of directors duties and are happy to advise and assist you.

We have offices conveniently located in Sutherland, Parramatta, Wollongong, Sydney CBD.