Corporate Governance: Directors’ Duties and Liabilities

PART B: CORPORATIONS LAW
Week 9:
Corporate Governance: Directors’ Duties and Liabilities
Lecture Notes
Topics for week 9
Weekly textbook reading: Business and Corporations Law (BCL) chapter 10
The topics to be covered in this class are:
● Directors’ fiduciary duties
● Corporations Act duties
● Duty of good faith and proper purpose
● Conflicts of interest and disclosure
● Duties of care, skill and diligence
● Consequences of contravention
● Duty to prevent insolvent trading.
Corporate governance is regulated by a mixture of legal rules and self-regulation. The legal
rules are found in fiduciary duties and the Corporations Act 2001 (Cth). The self-regulatory
aspects of governance involve voluntary codes of recommended good practices eg ASX
Corporate Governance Council
Corporate Governance Principles and Recommendations 4th
ed.
Fiduciary duties
Directors have a “fiduciary” relationship with their company and owe fiduciary duties to it.
This also applies in the case of senior managers of a company. Fiduciary duties are based
in
equitable principles which have been developed over centuries by the courts.
Case law: Hospital Products Ltd v United States Surgical Corp (1984) 156 CLR 41
Per Mason J:
“[T]he fiduciary undertakes or agrees to act for or on behalf of or in the
interests of another person in the exercise of a power or discretion which will affect the
interests of that person in a legal or practical sense. The relationship is therefore one which
gives the fiduciary a special opportunity to exercise the power or discretion to the detriment
of that other person by the fiduciary who is accordingly vulnerable to abuse by the fiduciary
of his position…
It is partly because of the fiduciary’s exercise of the power of discretion can adversely affect
the interests of the person to whom the duty is owed and because the latter is at the mercy
of the former that the fiduciary comes under a duty to exercise his power or discretion in the
interests of the person to whom it is owed
.”
Directors must:
● Act in good faith and in the best interests of the company;
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● Exercise their powers for proper purposes;
● Retain their discretionary powers;
● Avoid undisclosed conflicts of interest.
Director’s
fiduciary interests are supplemented by statutory duties in ss 180, 181, 182,
183 of the
Corporations Act 2001 (Cth).
Chapter 2D—Officers and employees
Part 2D.1—Duties and powers
179 Background to duties of directors, other officers and employees
(1) This Part sets out some of the most significant duties of directors, secretaries, other officers and
employees of corporations. Other duties are imposed by other provisions of this Act and other
laws (including the general law).
(2) Section 9 defines both
director and officer. Officer includes, as well as directors and secretaries,
some other people who manage the corporation or its property (such as receivers and liquidators).
Division 1—General duties
180 Care and diligence—civil obligation only
Care and diligence—directors and other officers
(1) A director or other officer of a corporation must exercise their powers and discharge their duties
with the degree of care and diligence that a reasonable person would exercise if they:
(a) were a director or officer of a corporation in the corporation’s circumstances; and
(b) occupied the office held by, and had the same responsibilities within the corporation as, the
director or officer.
Note: This subsection is a civil penalty provision (see section 1317E).
Business judgment rule
(2) A director or other officer of a corporation who makes a business judgment is taken to meet the
requirements of subsection (1), and their equivalent duties at common law and in equity, in
respect of the judgment if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably
believe to be appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.
The director’s or officer’s belief that the judgment is in the best interests of the corporation is a
rational one unless the belief is one that no reasonable person in their position would hold.
Note: This subsection only operates in relation to duties under this section and their
equivalent duties at common law or in equity (including the duty of care that arises
under the common law principles governing liability for negligence)—it does not
operate in relation to duties under any other provision of this Act or under any other
laws.
(3) In this section:
business judgment means any decision to take or not take action in respect of a matter relevant to
the business operations of the corporation.
181 Good faith—civil obligations
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Good faith—directors and other officers
(1) A director or other officer of a corporation must exercise their powers and discharge their duties:
(a) in good faith in the best interests of the corporation; and
(b) for a proper purpose.

Note 1:
Note 2:
This subsection is a civil penalty provision (see section 1317E).
Section 187 deals with the situation of directors of wholly-owned subsidiaries.
(2) A person who is involved in a contravention of subsection (1) contravenes this subsection.
Note 1:
Note 2:
Section 79 defines involved.
This subsection is a civil penalty provision (see section 1317E).

182 Use of position—civil obligations
Use of position—directors, other officers and employees
(1) A director, secretary, other officer or employee of a corporation must not improperly use their
position to:
(a) gain an advantage for themselves or someone else; or
(b) cause detriment to the corporation.

Note: This subsection is a civil penalty provision (see section 1317E).
(2) A person who is involved in a contravention of subsection (1) contravenes this subsection.
Note 1:
Note 2:
Section 79 defines involved.
This subsection is a civil penalty provision (see section 1317E).

183 Use of information—civil obligations
Use of information—directors, other officers and employees
(1) A person who obtains information because they are, or have been, a director or other officer or
employee of a corporation must not improperly use the information to:
(a) gain an advantage for themselves or someone else; or
(b) cause detriment to the corporation.

Note 1: This duty continues after the person stops being an officer or employee of the
corporation.
This subsection is a civil penalty provision (see section 1317E).
Note 2:
(2) A person who is involved in a contravention of subsection (1) contravenes this subsection.
Note 1:
Note 2:
Section 79 defines involved.
This subsection is a civil penalty provision (see section 1317E).

184 Good faith, use of position and use of information—criminal offences
Good faith—directors and other officers
(1) A director or other officer of a corporation commits an offence if they:
(a) are reckless; or
(b) are 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.
Note: Section 187 deals with the situation of directors of wholly-owned subsidiaries.
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Use of position—directors, other officers and employees
(2) A director, other officer or employee of a corporation 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.
(2A) To avoid doubt, it is not a defence in a proceeding for an offence against subsection (2) that the
director, other officer or employee of the corporation uses their position dishonestly:
(a) with the intention of directly or indirectly gaining an advantage for the corporation; or
(b) with the result that the corporation directly or indirectly gained an advantage.
Use of information—directors, other officers and employees
(3) A person who obtains information because they are, or have been, a director or other officer or
employee 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.
(4) To avoid doubt, it is not a defence in a proceeding for an offence against subsection (3) that the
person uses the information dishonestly:
(a) with the intention of directly or indirectly gaining an advantage for the corporation; or
(b) with the result that the corporation directly or indirectly gained an advantage.
185 Interaction of sections 180 to 184 with other laws etc.
Sections 180 to 184:
(a) have effect in addition to, and not in derogation of, any rule of law relating to the duty or
liability of a person because of their office or employment in relation to a corporation; and
(b) do not prevent the commencement of civil proceedings for a breach of a duty or in respect of a
liability referred to in paragraph (a).
This section does not apply to subsections 180(2) and (3) to the extent to which they operate on
the duties at common law and in equity that are equivalent to the requirements of
subsection 180(1).
Good faith and proper purpose
The courts have not finally decided whether the duty to act in good faith and in the best
interests of the company and for proper purposes involve a subjective or an objective test. It
does have an objective element. The duty is breached if a director acts in a way that
no
rational director
would have considered to be in the best interests of the company: ASIC v
Adler
[2002] NSWSC 171.
When a company is solvent, the best interests of the company will correspond with the best
interests of its shareholders as a collective group. If the company is insolvent or in financial
difficulties a duty will arise for directors not to prejudice the interests of the company’s
creditors.
The duty to act for proper purposes can arise in a variety of situations, including the issue of
shares. The power to issue shares is usually granted for the purpose of raising capital. The
duty can be breached if directors issue shares to maintain control of the company’s
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management or to create or destroy the voting power of majority shareholders.
Shareholders have the power to ratify an improper share issue. The High Court has stated
that where there is more than one purpose for a share issue, the “but for” test should be
applied to determine whether the directors issued shares for an improper purpose:
Whitehouse v Carlton Hotel (1987) 162 CLR 285.
Conflicts of interest and disclosure
Directors have a duty to avoid situations of conflict of interest. This means that directors
must not permit a situation to develop where there is a conflict between their duties to the
company and their own personal interests. If such a conflict does arise, directors have a
duty to disclose the conflict. Directors cannot improperly make a profit from their office.
The sorts of situations in which such a duty arises include:
● Self-interested transactions with the company
● Making personal profits from acting as a director (duty of disclosure arises)
● Taking bribes and other undisclosed benefits
● Misuse of company funds. Directors cannot mix company funds with their own.
● Taking up a corporate opportunity
● Misuse of confidential information
● Improper use of position (S 182 – this also applies to employees and company
officers)
● Improper use of information (s183 – this also applies to employees)
Directors’ fiduciary obligations most often require them to make full disclosure of their
potential conflicts of interest to the company’s shareholders at a general meeting and obtain
their consent. Section 191 of the Corporations Act also requires directors to disclose to
other directors. The constitution of a company may allow a director’s interest to be disclosed
and approved by the company’s directors instead of a general meeting of shareholders.
Directors of listed companies may be required to disclose to the ASX: s 205G.
Duties of care, skill and diligence
Directors have a duty to exercise a reasonable degree of care and diligence: see s 180 of
the Corporations Law. The duty of care also arises in the tort of negligence. The standard
under the statute and general law is the same: it is the standard of care of a “reasonable
person”. The standard of care expected of non-executive directors reflects their part-time
role.
Directors must take reasonable steps to put themselves in a position to guide and monitor
the management of the company. This includes the following:
● Becoming familiar with the company’s business when they join the board;
● Maintaining a continuing obligation to make inquiries and keep themselves
knowledgeable about all aspects of a company’s business;
● Becoming familiar with the company’s financial position by regularly reviewing
financial statements;
● Ensuring that the board has the means to monitor management so that they can be
satisfied that the company is being properly run;
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● Directors can make business judgments and take commercial risks but they must still
be informed in doing so. Directors and other officers will avoid liability for breach of
their duty of care if they can satisfy the business judgment rule outlined in s 180(2):
Business judgment rule
S 180 (2) A director or other officer of a corporation who makes a business
judgment
is taken to meet the requirements of subsection (1), and their equivalent
duties at common law and in equity, in respect of the judgment if they:
(a) make the judgment
in good faith for a proper purpose; and
(b) do
not have a material personal interest in the subject matter of the
judgment; and
(c)
inform themselves about the subject matter of the judgment to the
extent they reasonably believe to be appropriate; and
(d)
rationally believe that the judgment is in the best interests of the
corporation.
The director’s or officer’s belief that the judgment is in the best interests of the
corporation is a rational one unless the belief is one that no reasonable person in their
position would hold.
● Directors cannot close their eyes to corporate misconduct and then claim they did not
see it or did not need to make inquiries
● The Chair of a listed company has special responsibilities and is subject to a higher
standard of care and diligence, as are executive directors in comparison with
non-executive directors.
● Reliance on others defence s 189
189 Reliance on information or advice provided by others
If:
(a)
a director relies on information, or professional or expert advice,
given or prepared by:
(i)
an employee of the corporation whom the director believes on
reasonable grounds to be reliable and competent in relation to the matters concerned;
or
(ii)
a professional adviser or expert in relation to matters that the
director believes on reasonable grounds to be within the person’s professional or
expert competence; or
(iii
) another director or officer in relation to matters within the
director’s or officer’s authority; or
(iv)
a committee of directors on which the director did not serve in
relation to matters within the committee’s authority; and
(b) the reliance was made:
(i
) in good faith; and
(ii) after making an
independent assessment of the information
or advice
, having regard to the director’s knowledge of the corporation and the
complexity of the structure and operations of the corporation; and
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(c) the reasonableness of the director’s reliance on the information or
advice arises in proceedings brought to determine whether a director has performed a
duty under this Part or an equivalent general law duty;
the director’s
reliance on the information or advice is taken to be reasonable
unless the contrary is proved.
S 190 Responsibility for actions of delegate
(1) If the directors delegate a power under section 198D, a director is responsible for
the exercise of the power by the delegate as if the power had been exercised by the directors
themselves.
(2) A director is not responsible under subsection (1) if:
(a) the director believed on reasonable grounds at all times that the delegate
would exercise the power in conformity with the duties imposed on directors of the company
by this Act and the company’s constitution (if any); and
(b) the director believed:
(i) on reasonable grounds; and
(ii) in good faith; and
(iii) after making proper inquiry if the circumstances indicated the need for
inquiry;
that the delegate was reliable and competent in relation to the power
delegated.
Consequences of contravention
The company itself is usually the proper entity to remedy wrong done to the company
by its directors. If the company is in liquidation the liquidator can bring the action in
the name of the company.
Remedies for the company include:
● Compensation or damages
● Account of profits made by a director
● Rescission of a contract with a director
● Injunction to prevent further breaches of duty
● Order requiring return of property to the company
ASIC may also have remedies for breaches of statutory remedies.
Duty to prevent Insolvent Trading
Directors must stop a company incurring debts if there are reasonable grounds for believing
that the company is insolvent: s 588G. If no defences can be made out, directors who
breach this duty may be required to pay compensation to the company of an amount equal
to the loss or damage suffered by the unsecured creditors.
Defences to insolvent trading are found in s 588H:
● It is a defence if a director proves that at the time the debt was incurred, the director
had reasonable grounds to suspect, and did suspect, that the company was solvent
and would remain solvent even if it incurred the debt;
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● It is a defence if a director has delegated monitoring of the company’s financial
position to others upon whom the director relied and that there were reasonable
grounds for believing that a competent and reliable person was providing adequate
information about whether the company was solvent and the other person was
fulfilling that responsibility
● It is a defence if a director is absent from management because of illness or some
other good reason when the debt is incurred.
● It is a defence if the director proves that he/she took all reasonable steps to prevent
the company from incurring the debt.
Section 588GA contains a “safe harbour” defence for directors from civil liability for
insolvent trading.
The ‘safe harbour defence’, was designed to encourage company
directors to attempt to restructure companies that are at risk of insolvent trading,
rather than simply placing the company into voluntary administration at the first sign
of trouble. The safe harbour defence was part of a set of legislative changes to the
Corporations Act that were designed to remove some of the barriers to restructuring
faced by struggling companies and their directors.
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