LIABILITY OF COMPANY DIRECTORS IN 2010
D.F. Jackson QC* and Jack Hynes**
North Queensland Law Association Conference
29 May 2010
A.
INTRODUCTION
Recent times have seen once again an increased level of interest in the roles played by
directors of corporations and, more particularly, in the duties that are imposed on
those who accept the office of director. The global financial crisis too has brought into
focus the responsibilities of directors to the company (having regard to the interests of
members, creditors and employees), especially in the context of potential insolvency.
The judgments in a number of high profile prosecutions of directors by the Australian
Securities and Investments Commission (ASIC) in 2009 have thrown a spotlight on
the behaviour of corporate officers and on the ability of ASIC to regulate that
behaviour.
Two significant judgments delivered in 2009 were the judgments of the Supreme
Court of New South Wales in Australian Securities and Investments Commission v
Macdonald (No 11)1 (Macdonald), a victory for the corporate regulator in
proceedings commenced against current and former officers of James Hardie
Industries Limited, and Australian Securities and Investments Commission v Rich2
(Rich), which saw the failure of ASIC’s prosecution of two directors of failed
telecommunications company One.Tel Limited after eight years and substantial legal
costs.
In the wake of the judgments in Macdonald and Rich (as well as the high profile
failures of prosecutions of directors of AWB Limited and Fortescue Metals Limited),
ASIC has made it clear that it intends to continue aggressively to pursue directors who
* Seven Wentworth, 126 Phillip Street, Sydney, 2000
** Barrister, Seven Wentworth, 126 Phillip Street, Sydney, 2000
1
[2009] NSWSC 287
2
[2009] NSWSC 1229
1
may have breached their duties. ASIC chairman Mr Tony D’Aloisio has stated earlier
in the year that ASIC will push the “regulatory regime to the limit” in enforcing
obligations of directors.3 The topic of the liability of company directors in 2010 is
thus a very relevant and important one for the legal and business community.
B.
THE ROLE OF DIRECTORS AND NATURE OF DUTIES
The vesting in the directors of a corporation of the power to control the corporation
and its property gives rise to a risk, which can be substantial, that those powers will be
misused to the detriment of the corporation and its shareholders. To counter this risk,
directors are subject to both fiduciary and statutory duties.4
In Re Barings plc; Secretary of State for Trade and Industry v Baker,5 Sir Richard
Scott VC referred to a director’s special and privileged position and the
responsibilities that correspond with that privileged position:
“the … higher the office within an organisation that is held by an individual,
the greater responsibilities that fall upon him. It is right that that should be so,
because status in an organisation carries with it commensurate rewards.
These rewards are matched by the weight of the responsibilities that the
office carries with it and those responsibilities require diligent attention from
time to time to the question whether the system that has been put in place and
over which the individual is presiding is operating efficiently, and whether
individuals to whom duties, in accordance with the system, have been
delegated are discharging those duties efficiently.6”
The Commonwealth Parliament has recognised the “weight of the responsibilities”
which are to be borne by directors and has legislated a number of general and specific
duties for directors in the Corporations Act 2001. The key provisions are contained in
ss. 180 to 184 of the legislation. While these provisions are in addition to the fiduciary
duties arising at general law (see s. 185), the provisions in large measure restate the
general law position.
3
Patrick Durkin, “ASIC warns directors on breaches”, The Australian Financial Review (Sydney), 27
January 2010
4
Austin, Ford & Ramsay, Company directors: principles of law and corporate governance, LexisNexis
Butterworths, 2005 at 210
5
[1998] BCC 583
6
[1998] BCC at 586. See also ASIC v Rich & Ors [2004] NSWSC 836 at [86] per White J
2
Directors’ duties can be placed into the following general classes:
1.
The general law duty of care imposed upon a director. This duty is
supplemented by the statutory duty to act with care and diligence pursuant to s.
180(1) of the Corporations Act.
2.
The general law duty to act honestly and in the best interests of the company.
This duty is supplemented by the requirement under s. 181(1)(a) of the
Corporations Act for directors to act in good faith in the best interests of the
corporation.
3.
The general law duty to exercise powers for proper purposes. This duty is
supplemented by s. 181(1)(b) of the Corporations Act which requires directors
to exercise their powers and discharge their duties for proper purposes.
4.
The general law duty of loyalty. This duty incorporates the rules in relation to
conflicts and personal profits. The duty is supplemented by the various
requirements under ss. 182(1), 183(1), 191 – 196 and Chapter 2E7 of the
Corporations Act which concern the requirement to disclose certain interests,
related party transactions and the requirement not to misuse information or the
position of a director to gain personal advantage.
5.
The statutory duty on directors to prevent a company from engaging in
insolvent trading pursuant to s. 588G of the Corporations Act. This perhaps may
be regarded as falling within the general law duty of care referred to in
paragraph 1.
6.
Other statutory duties concerning the operation and administration of a
corporation including the requirements concerning the lodgement of documents
with ASIC, members meetings, and financial statements and reports.
The consequences of breach of the various duties range from civil penalties,
disqualification from management, fines and in some instances criminal prosecution.
This topic is dealt with collectively at the end of the paper.
7
Sections 207 to 230
3
C.
THE DUTY OF CARE, SKILL AND DILIGENCE
The general law prescribes a duty on directors to take reasonable care in the
performance of the office. The standard of care is an objective one, assessed by
reference to the size of the business of the particular company, and the experience or
skills that the director held him or herself out to hold in support of the appointment.8
Section 180(1) of the Corporations Act imposes a duty of care and diligence on
directors in the following terms:
“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.”
The statutory duty in s. 180(1) substantially reflects the duty of care and skill imposed
on directors at general law.9
The minimum standard
The provision and the common law impose an objective reasonable person standard.
A significant factor to be taken into account when assessing whether there has been a
contravention of the provision is the “corporation’s circumstances”. There are
numerous factors relevant to this assessment, including the size and nature of the
company's business, the composition of the board, the director’s position and
responsibilities within the company, the particular function the director is performing,
the experience or skills of the particular director, the terms on which he or she has
undertaken to act as a director, the manner in which responsibility for the business of
8
9
Daniels v Anderson (1995) 37 NSWLR 438 at 665 per Clarke and Sheller JJA
Daniels v Anderson 37 NSWLR at 602 per Powell J
4
the company is distributed between its directors and its employees, and the
circumstances of the specific case.10
Having regard to the corporation’s circumstances, the law then requires a minimum
standard of care and diligence that is expected of directors. In order to meet the
standard, directors are required to ensure that they are in a position to properly guide
and monitor a company’s management.11 The courts expect the following from
directors in meeting this minimum standard:
(a)
to become familiar with the fundamentals of the business or businesses of
the corporation;
(b)
to stay informed about the corporation’s activities and monitor the
corporation’s activities generally;
(c)
to maintain familiarity with the financial status of the corporation by
appropriate means; and
(d)
to have a reasonably formed opinion of the corporation’s financial
capacity.12
A very recent consideration of an application of the provision is seen in Rich where
Austin J stated that the relevant standard, as in a professional negligence case,
“recognises a distinction between negligence and mere mistakes” or errors of
judgment.13 Having regard to this distinction, his Honour noted:
“[t]he statutory issue under s 180(1) is not whether the defendants made
mistakes in the process of financial forecasting, and a fortiori, it is not
whether they formed opinions different from the opinions of ASIC or of the
court. The statutory issue is whether they failed to meet the standard of care
and diligence that the statute lays down. The statute requires the court to
apply a standard defined in terms of the degree of care and diligence that a
reasonable person would exercise, taking into account the corporation's
circumstances, the offices occupied by the defendants and their
responsibilities within the corporation. That requires the defendants' conduct
to be assessed with close regard to the circumstances existing at the relevant
10
ASIC v Maxwell [2006] NSWSC 1052 at [100], the reasoning of which was adopted by Gzell J in
MacDonald at [236]
11
Daniels v Anderson (1995) 37 NSWLR 438 at 501 per Clarke JA and Sheller JA
12
[2009] NSWSC 1229 at [7203]. See also ASIC v Adler [2002] NSWSC 171 at [372]
13
[2009] NSWSC 1229 at [7239]
5
time, without the benefit of hindsight, and with the distinction between
negligence and mistakes or errors of judgment firmly in mind. If the
impugned conduct is found to be a mere error of judgment, then the statutory
standard under s 180(1) is not contravened.14”
The law has recognised that, particularly in large enterprises, it will be necessary for
directors to rely on information and advice provided by other officers of the
corporation. In ASIC v Adler [2002] NSWSC 171 at [372], Santow J stated that “a
director is entitled to rely without verification on the judgment, information and
advice of management and other officers appropriately so entrusted”. His Honour
further noted, however, that “reliance would be unreasonable where directors know,
or by the exercise of ordinary care should have known, any facts that would deny
reliance on others”.15
Application of standard to non-executives and the Chairman
A different degree of standard will apply to directors depending upon their particular
role. Austin J recognised in Rich that the wording of the standard imposed by the
statutory duty of care and diligence is intended to “make it clear... that non-executive
directors are not subject to the same (higher) standard as executive directors, and
partly to affirm that the statutory standard, while related to the office held and the
responsibilities of that office, was intended to be an objective standard”.16
Accordingly, the standard under the provision will have a more limited application to
non-executive directors.
In MacDonald Gzell J noted that “the law has not yet established the extent to which
the position of a non-executive director shapes the content of the duty of care”.17
Nevertheless, his Honour was prepared to find that the actions of the non-executive
directors in approving the draft release document constituted a breach of the statutory
duty of care and diligence.18
14
[2009] NSWSC 1229 at [7242]
See also ASIC v Maxwell [2006] NSWSC 1052 at [101]
16
[2009] NSWSC 1229 at [7196]
17
[2009] NSWSC 287 at [250]
18
[2009] NSWSC 287 at [259]-[260]
15
6
On the other hand, the role of chairman in a public company has special
responsibilities and has been held to be subject to a much higher standard. The
chairman has been held to have the primary responsibilities associated with directing
the company’s board and the company’s promotion generally.19
Business judgment rule
The business judgment rule contained in section 180(2) provides protection from
liability for a breach of s. 180(1) where decisions are made in certain prescribed
circumstances.
Section 180(2) and (3) provide:
“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.
(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.”
The rule has had little judicial consideration since it was introduced by the Corporate
Law Economic Reform Program Act 1999 (Cth) (1998 CLERP Act). The Explanatory
Memorandum to 1998 CLERP Act noted that the purpose of the purpose of the
business judgment rule is to provide a “safe harbour from personal liability in relation
to honest, informed and rational business judgments” which involve “responsible risktaking” and further notes that:
19
AWA Limited v Daniels (1992) 7 ACSR 759 at 1014 which reasoning was accepted in ASIC v Rich
7
“[w]hile the substantive duties of directors will remain unchanged, absent
fraud or bad faith, the business judgment rule will allow directors the benefit
of a presumption that, in making business decisions, if they have acted on an
informed basis, in good faith, and in the honest belief that the decision was
taken in the best interests of the company, they will not be challenged
regarding the fulfilment of their duty of care and diligence.20”
The judgment of Austin J in Rich set out what his Honour considered s. 180(2) was
capable of in providing a defence to an alleged breach of s. 180(1), namely where:
(a)
the impugned conduct is a business judgment as defined;
(b)
the directors or officers are acting in good faith, for proper purpose and
without any material personal interest in the subject matter;
(c)
they make their decision after informing themselves about the subject
matter to the extent they believe to be appropriate;
(d)
their belief about the appropriate extent of information gathering is
reasonable in terms of the practicalities of the information gathering
exercise (including such matters as the accessibility of information and
the time available to collect it);
(e)
they believe that their decision is in the best interests of the
corporation; and
(f)
that belief is rational in the sense that it is supported by an arguable
chain of reasoning and is not a belief that no reasonable person in their
position would hold.21
Beyond its role in providing a defence to a claim that s. 180(1) has been breached,
Austin J also saw that “on a practical level s. 180(2) articulates criteria that can be a
reference point for directors and officers and their advisers, and can offer a direct
solution to the issue of breach of duty in a straightforward case”.22
[2003] NSWSC 85 at 61
20
Commonwealth, Corporate Law Economic Reform Program Bill Explanatory Memorandum (1998)
at [6.1]-[6.4]
21
[2009] NSWSC 1229 at [7294]
22
[2009] NSWSC 1229 at [7254]
8
Reliance on others and delegation
In addition to the business judgment rule, directors may be afforded further protection
in the reliance and delegation provisions contained in ss. 189 and 190 of the
Corporations Act.
In general terms s.189 provides that directors are permitted to rely upon information
or advice provided by an employee, professional advisor or expert whom the director
believes on reasonable grounds to be reliable and competent in relation to the matters
concerned. The provision also enables directors to rely upon other directors or a
committee of directors (on which the director does not serve) in relation to matters
within the director’s authority.
The reliance must be made in good faith and after the director makes an independent
assessment of the information or advice having regard to the director’s knowledge of
the company and the complexity of the structure and operations of the company.23
Where information that has been relied upon by a director that falls within the ambit
of the provision, the director’s reliance on the information or advice is taken to be
reasonable unless the contrary is proved.
The delegation provision contained in s. 190 complements the reliance provision
contained in s. 189. Pursuant to s. 190(1) a director is generally liable for the actions
of those that have received delegated powers from the director under s. 198D, which
allows the directors of a company, unless its constitution otherwise provides, to
delegate any of their powers to a committee of directors, to a director, to an employee
or to any other person. The saving provision is contained in s. 190(2) which allows a
director to avoid liability for the actions of a delegate in circumstances where the
director believed on reasonable grounds that the delegate would exercise the power in
conformity with the statutory duties under the Corporations Act and the requirements
under the company’s constitution. Under this provision, the director must have also
believed on reasonable grounds, in good faith and (in some cases) after making proper
inquiry, that the delegate was reliable and competent in relation to the delegated
power.
23
Corporations Act 2001, s. 189(b)
9
D.
DUTY TO ACT HONESTLY, IN GOOD FAITH IN THE BEST INTERESTS OF THE
CORPORATION
The duty to act in good faith and for a proper purpose also has an established basis as
a fiduciary duty under the general law. The duty for a director to act with integrity and
honesty is said to be fundamental and at the heart of ethical standards in business.24
The general law has developed a mixed objective and subjective standard which
requires directors to determine what is in the best interests of the company, while
observing a standard applicable to an intelligent director in the relevant director’s
position.25
The duty is also enshrined in s. 181 which provides:
“181 Good faith—civil obligations
Good faith—directors and other officers
(1)
(2)
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.
A person who is involved in a contravention of subsection (1)
contravenes this subsection.”
In good faith in the best interests of the corporation
The question whether a director acts in good faith in the best interests of a corporation
has had wide judicial consideration. It has been said that it not the case that the
question is determined on a purely subjective basis. Bowen LJ said in Hutton v West
Cork Railway Co26:
“Bona fides cannot be the sole test, otherwise you might have a lunatic
conducting the affairs of the company, and paying away its money with both
hands in a manner perfectly bonafide yet perfectly irrational.27”
24
Austin, Ford & Ramsay, Company directors: principles of law and corporate governance,
LexisNexis Butterworths, 2005, at 272
25
Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] 1 Ch 62
26
(1883) 23 Ch D 654
27
23 Ch D at 671
10
On the same note Santow J said in ASIC v Adler that the provision will not be
complied with by “subjective good faith or by a mere subjective belief by a director
that his purpose was proper”.28
While the test has thus had a significant objective aspect, in Macdonald Gzell J
rejected ASIC’s claim that there was a breach under s. 181(1). In doing so he had less
regard for an objective analysis. He said in rejecting this aspect of ASIC’s claim:
“...there was no conflict between [Macdonald’s] personal interest and that of
JHIL. He did not take advantage of his position to make a secret profit. He
did not misappropriate the company’s assets for himself. Like the nonexecutive directors in approving Draft ASX Announcement, Mr Macdonald
may have believed it was in the best interests of JHIL to be as emphatic as he
could in selling the Separation Proposal. The evidence does not establish that
Mr Macdonald acted for an improper or collateral purpose. Objectively
judged, Mr Macdonald was overzealous, but he was overzealous in the
interests of JHIL.29”
To arrive at this conclusion, Gzell J considered that the provision is “contravened only
where a director engaged deliberately in conduct, knowing that it is not in the interests
of the company”.30 Gzell J’s emphasis on the subjective thinking of the director
might be seen as a move away from the objective analysis that the case law has
developed on the topic.31
The question also arises as to what is in “the best interests of the company”. While the
obvious answer is the interests of existing members as proprietors of the company, the
obligation has also been seen to extend to a wider group, including to the interests of
future members of a company32, and to the interests of a company as a commercial
entity, capable of returning a benefit to members.33
A relevant and topical question is whether the interests of creditors fall within the
range of the interests covered by the provision. In The Bell Group (in liq) v Westpac
28
[2002] NSWSC 171 at [738]
[2009] NSWSC 287 at [669]
30
[2009] NSWSC 287 at [662] – [663]
31
Some commentary has gone so far as to regard this particular aspect of Gzell J’s finding to be a
“disturbing weakening of the standards of conduct and review pertinent to directors” (see Julie Cassidy,
“James Hardie: The resurrection of Re City Equitable and Beyond?” (2009) 37 ABLR 312 at 322)
32
Provident International Corp v International Leasing Corp Ltd [1969] 1 NSWLR 424 at 440
33
Ngurli Ltd v McCann (1953) 90 CLR 425 at 438
29
11
Banking Corporation Owen J considered that a director’s duty to act in the best
interest of the company includes, in certain circumstances, an obligation to have
regard to the interests of creditors. In this respect, his Honour said:
“[i]n my view the true state of the law is this. A director has a duty to act in
the best interests of the company. The duty is owed to the company and not to
any third parties (including creditors). But in an insolvency context (and I
will narrow that concept shortly) the duty entails or includes an obligation on
the directors to take into account the interests of creditors. Why should this be
so? The answer is, as Mason J said in Walker v Wimborne, any failure by the
directors to take into account the interests of creditors will have adverse
consequences for the company as well as for the creditors. What are those
consequences? They are many, but they include threats to the very existence
of the company: to its ability to continue as a going concern.34”
While it still appears to be the case that directors do not have a “duty” to creditors35,
the authorities (including what we have recently seen in the approach taken in The
Bell Group (in liq)) provide that a director will at least need to have regard to a
creditor’s interest in the context of a corporate insolvency.36
E.
THE DUTY TO ACT FOR A PROPER PURPOSE
Under the general law, in order to give effect to a director’s duty to act in the
company’s best interests, directors must also exercise their powers for a proper
corporate purpose. For this to occur, directors must ensure that their powers are
exercised for the purpose for which they were conferred.37
In relation to s. 181(1)(b) (which is set out above), the provision requires that the
director acts for a “proper purpose”. In this respect the case law has developed a
number of guiding propositions relevant to the assessment of what is a “proper
purpose”, namely:
(a)
fiduciary powers granted to directors are to be exercised for the purpose
for which they were given, not collateral or improper purposes;
34
The Bell Group Limited (in liq) v Westpac Banking Corporation & Ors [2008] WASC 239 at [4418]
Spies v The Queen (2000) 201 CLR 603
36
Kalls Enterprises Pty Ltd (in liq) v Baloglow [2007] NSWCA 191 at [162]
37
Mills v Mills (1938) 60 CLR 150 at 169
35
12
(b)
for there to be a breach of the provision, the substantial purpose of
directors must be shown to have been improper or collateral to the duties
as a director;
(c)
honest or altruistic behaviour does not prevent a finding of improper
conduct; and
(d)
the court must determine whether, but for the improper or collateral
purpose, the directors would have performed the act in dispute.38
Accordingly, there are two primary mattes considered by courts in considering
whether powers have been discharged for a proper purpose: the objective purpose for
which the power was granted, and the purpose which motivated the power’s exercise.
Common instances where powers have been found to have been exercised improperly
arise in the context of share issues. Directors will be breaching their obligations in this
respect where shares are issued to maintain control of the company’s majority
shareholding or dilute the voting power of members.39
F.
THE DUTY TO AVOID CONFLICTS
Under the general law, directors are required to avoid positions of conflict. This
requirement stems from the duty to serve another’s interests.40 Sir Frederick Jordan’s
observation, cited by Deane and Mason JJ in Hospital Products Ltd v US Surgical
Corp (1984) 156 CLR 41 at 103, was:
“It has often been said that the person who occupies a fiduciary position
ought to avoid placing himself in a position in which his duty and his interest,
or two different fiduciary duties conflict. This is rather a counsel of prudence
than a rule of equity, the rule being that a fiduciary must not take advantage
of such a conflict if it arises.41”
38
Permanent Building Society (in liq) v Wheeler (1994) 14 ACSR 109 at 218; The Bell Group Limited
(in liq) v Westpac Banking Corporation & Ors [2008] WASC 239 at [4466]
39
Nguli Limited v McCann (1953) 90 CLR 425; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC
821
40
North-West Transport Co. Ltd v Beatty (1877) 1 App Cas 589
41
F Jordan, Chapters on Equity in NSW (6th ed, 1947), p. 115
13
The general duty to avoid conflicts encapsulates a range of related statutory duties and
obligations under the Corporations Act which deal with the requirements to disclose
certain interests, and the regulation of the manner in which directors are to deal with
benefits that they may receive in their position as such.
Disclosure of material personal interests
There are several statutory provisions relevant to the duty on directors to disclose
conflicts and they are primarily contained in ss. 191 – 196 of the Corporations Act.
Section 191(1) provides:
“191 Material personal interest—director’s duty to disclose
Director’s duty to notify other directors of material personal interest when
conflict arises
(1)
A director of a company who has a material personal interest in a
matter that relates to the affairs of the company must give the other
directors notice of the interest unless subsection (2) says otherwise.”
Section 191(2) sets out numerous exemptions including where the interest arises
because the director is a member of the company, and the interest is held in common
with other members (subsection (2)(a)(i)). A further exemption includes where the
interest is in a contract and the interest arises merely because the director is a director
of the related body corporate (subsection (2)(a)(viii)).
The concept of “material personal interest” is fundamental to the assessment of
whether there has been a breach of the provision. While this is an undefined term
under the legislation, it has been held that the interest must be one of some substance
or value, rather than a slight interest.42 A simple example of such an interest would
include where the director involves himself or herself in board discussions concerning
whether the company should issue shares to that director.43
Section 192 of the Corporations Act provides:
42
43
Grand Enterprises Pty Ltd v Aurium Resources Ltd [2009] FCA 513 at [68]
McGellin v Mount King Mining NL (1998) 144 FLR 288
14
“192 Director may give other directors standing notice about an interest
Power to give notice
(1)
A director of a company who has an interest in a matter may give the
other directors standing notice of the nature and extent of the interest in
the matter in accordance with subsection (2). The notice may be given
at any time and whether or not the matter relates to the affairs of the
company at the time the notice is given.”
The provision goes on to detail what is required in the standing notice and what must
be done with it in order for the notice to be valid and effective.
Section 193 provides that the provisions contained in ss. 191 and 192 are in addition
to any general law duty regarding conflicts of interest, as well as any provision in a
company’s constitution that restricts a director from having a material personal
interest in a matter or from holding office or possessing property.
The replaceable rule contained in s. 194 allows directors of a proprietary limited
company to contract with the company where there has been a proper disclosure of
their interests.
In the case of public companies, s. 195 imposes a restriction upon directors
participating in meetings (being present and voting) which consider a matter in which
they have an interest, although this requirement can be overcome if other directors
approve.
Financial benefits – Chapter 2E
Chapter 2E of the Corporations Act was introduced to protect members of a public
company by requiring member approval before the company gave financial benefits to
parties including directors. The provisions were intended to prevent “uncommercial
transactions” that have the potential to adversely affect shareholders’ interests.44
Section 208 is the key provision of Chapter 2E. The provision prevents a public
company, or an entity that it controls, providing a “financial benefit” to a related party
of the company, unless there has been a general meeting approval in relation to the
provision of the benefit, or the benefit is exempt. Related parties are defined under s.
44
Explanatory Memorandum accompanying 1992 amendments
15
228 to include directors of the public company as well as parents, spouses and
children of the directors.
Section 229 provides a list of guidelines relevant to the assessment of what is to be
considered a “financial benefit”. Sections 210 – 216 provide a number of exemptions
including benefits given on terms that are less favourable than arm’s length terms (s.
210) or are director’s reasonable remuneration (s. 211). Under s. 208(1)(a), unless an
exemptions applies, the benefit must be approved by a fully informed general meeting
constituted in accordance with Division 3 of the Corporations Act.
Improper use of position
As part of the duty of loyalty, directors are under a fiduciary duty not to make
undisclosed personal profits or gains while acting as such, and must account for
profits that they have received as a result of their position. The obligation is limited to
those profits that the fiduciary actually receives, and not for the profits received by
another party as a result of the breach.45 The duty is complemented by s. 182 of the
Corporations Act which provides:
“182 Use of position—civil obligations
Use of position—directors, other officers and employees
(1)
(2)
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.
A person who is involved in a contravention of subsection (1)
contravenes this subsection.”
Establishing whether a director has made an improper use of the director’s position is
an objective assessment made by reference to the position of a reasonable person with
the relevant knowledge. In Doyle v ASIC (2005) 227 CLR 18 at [37] the High Court
considered that impropriety may consist in the doing of an act for which the officer
ought to know there was an absence of authority and that “there was no safe haven for
the morally obtuse”.
45
Warman International Ltd v Dwyer (1995) 182 CLR 544 at 554
16
The provision has wide scope and can extend to other persons or entities receiving the
benefit. An example of a contravention of the duty has been found to be where a
financially troubled director caused the company to repay loans to him, which action
caused detriment to other creditors of the company.46 A more extreme recent example
has been where the director has caused the company to pay substantial amounts
purportedly as a bonus to an entity controlled by the director, where in fact the alleged
bonus was not payable, and the company’s financial position was dire.47
Use of information
The improper use of information for the director’s own benefit is a similar duty that
originates in the director’s fiduciary obligation concerning the use of confidential
information. At general law, a director owes a fiduciary duty not to misuse
confidential information for his or her own benefit without first giving appropriate
disclosure and obtaining appropriate approval.48
The statutory duty essentially mirrors the preceding duty concerning use of position.
Section 183 provides:
“183 Use of information—civil obligations
Use of information—directors, other officers and employees
(1)
(2)
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.
A person who is involved in a contravention of subsection (1)
contravenes this subsection.”
The law that has developed concerning s. 182 would seem to apply equally to claims
made under s. 183 and particularly in relation to the question of what is “improper
use”. It has also been said that plaintiffs will often simply proceed under s. 182 rather
46
Grove v Flavel (1986) 4 ACLC 654
Diakyne Pty Limited v Ralph (2009) 72 ACSR 450
48
Facenda Chicken Limited v Fowlwer [1987] 1 Ch 117; Riteway Express Pty Ltd v Clayton (1987) 10
NSWLR 238
47
17
than s. 183 due to the onerous requirement to establish the “use” of the particular
information.49
It is of note that the statutory provision is not confined to use of “confidential”
information. Young J considered in Rosetex Co Pty Ltd v Licata (1994) 12 ACLC 269
that “information” (for the purpose of the predecessor State provision) referred to the
type of information that the fiduciary obligation would restrict disclosure of. This
approach was rejected recently by Windeyer AJ in ASIC v Sommerville [2009]
NSWSC 934 where his Honour preferred the ordinary and wide interpretation being
to simply have “knowledge of the facts”.50
G.
THE DUTY TO PREVENT INSOLVENT TRADING
A director has a statutory duty to prevent insolvent trading by the company. This duty
may be regarded as part of the duty of care owed by a director to the company.
Section 588G(1) and (1A) of the Corporations Act provide:
“588G Director’s duty to prevent insolvent trading by company
(1)
This section applies if:
(a)
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 that debt, or by incurring at that time debts including
that debt; and
(c)
at that time, there are reasonable grounds for suspecting that the
company is insolvent, or would so become insolvent, as the case
may be; and
(d)
that time is at or after the commencement of this Act.
(1A) For the purposes of this section, if a company takes action set out in
column 2 of the following table, it incurs a debt at the time set out in
column 3.”
Under this provision, insolvent trading will occur where it can be shown that the
company incurs debts in circumstances where there are reasonable grounds for
suspecting that the company is insolvent. In Hawkins v Bank of China (1992) 26
49
Austin, Ford & Ramsay, Company directors: principles of law and corporate governance,
LexisNexis Butterworths, 2005 at 388
50
See also MacNamara v Flavell (1988) 6 ACLC 802 which was applied by Windeyer AJ
18
NSWLR 562 at 577 Kirby P identified the single purpose of the predecessor
provision:
“[t]he whole purpose of object of [the provision] was to discourage officers
of corporations from improvidently committing the corporation to obligations
to pay money as a debt when they have reasonable grounds for supposing that
their corporation is (or will, upon incurring the debt in question) become
insolvent.”
If a company’s operation falls within the scope of the provision, directors are
expected to take steps to relinquish their control of the company so that creditors can
decide on the company’s future (such as pursuant to the administration provisions
contained in Pt 5.3A).
Incurring a debt
In order to establish a contravention of s. 588G it must be shown, under s. 588G(1)(a)
that the company “incurs a debt”. In Hawkins v Bank of China at 576 the Court found
that a debt will be incurred when the company “so acts to expose itself contractually
to an obligation to make a future payment of a sum of money as a debt”.
In ASIC v Plymin (No. 1) (2003) 175 FLR 124 at [516] Mandie J referred to the weight
of authority as showing that a debt can be incurred when the contract giving rise to the
debt is entered into and that this is so even if there are contingencies that will affect
the debt, or the debt is a future one. His Honour considered that rather than analysing
the strict legal terms of a contract to assess when a debt will arise, the approach to be
taken is to assess the issue by reference to the real “substance and commercial reality”
in order to establish when the company is exposed to the relevant liability.51
Section 588G(1A) contains a “debt table” which sets out the times at which particular
debts will arise. These circumstances relate to transactions that occur other than in the
ordinary course of trade, and they relate the company’s share capital or its entry into
uncommercial transactions.
51
ASIC v Plymin (No. 1) (2003) 175 FLR 124 at [516]
19
Insolvent transactions
In order to establish a contravention of s. 588G it must also be shown, under s.
588G(1)(b), that the company was insolvent at the time that the debt was incurred, or
became insolvent by reason of the debt being incurred.
Section 95A provides a definition of insolvency in the following terms:
“95A Solvency and insolvency
(1)
A person is solvent if, and only if, the person is able to pay all the
person’s debts, as and when they become due and payable.
(2)
A person who is not solvent is insolvent.”
The test applied by the courts in assessing whether a company meets the criterion of
insolvency contained in s. 95A is the cash flow test, rather than a simple assessment
of a company’s balance sheet. The test requires a relatively in-depth analysis of the
company’s trading history and in particular its financial position as a whole. Palmer J
in Southern Cross Interiors Pty Limited (in liq) v Deputy Commissioner of Taxation
(2001) NSWLR 123 at 224 -225 said of this assessment:
“[i]n considering the company's financial position as a whole, the Court must
have regard to commercial realities. Commercial realities will be relevant in
considering what resources are available to the company to meet its liabilities
as they fall due, whether resources other than cash are realisable by sale or
borrowing upon security, and when such realisations are achievable.
In assessing whether a company's position as a whole reveals surmountable
temporary illiquidity or insurmountable endemic illiquidity resulting in
insolvency, it is proper to have regard to the commercial reality that, in
normal circumstances, creditors will not always insist on payment strictly in
accordance with their terms of trade but that does not result in the company
thereby having a cash or credit resource which can be taken into account in
determining solvency.
The commercial reality that creditors will normally allow some latitude in
time for payment of their debts does not, in itself, warrant a conclusion that
the debts are not payable at the times contractually stipulated and have
become debts payable only upon demand.”
The inquiry is therefore a broad one which has regard to commercial realities arising
in the company’s ordinary course of business.
20
Reasonable grounds for suspecting
Section 588G(1)(c) requires that there must be reasonable grounds for suspecting that
the company was insolvent at the time that a debt was incurred.
The test for determining what are “reasonable grounds” has been held to be objective
and one undertaken by reference to the standard of reasonableness appropriate to a
“director of reasonable competence and diligence, seeking properly to perform his
duties as imposed by law (when viewed as a whole) and capable of reaching a
reasonably formed opinion as to a company’s financial capacity”.52
The element of “suspecting” under s. 588G(1)(c) imposes a higher obligation on
directors to participate in the monitoring of a company’s financial position, than did
the predecessor provision which required only that the director had reasonable
grounds to “expect” insolvency.
Subsections 588G(2)(a) and 588G(2)(b) provide alternative tests to establish a
contravention under the provision. Under subsection (2)(a), the assessment is whether
the particular director was subjectively aware of the facts that would constitute
reasonable grounds for suspecting the insolvency. Under subsection (2)(b), the
assessment is whether it can be shown that a reasonable person (in the director’s
position) would be aware of the existence of facts constituting reasonable grounds for
suspecting insolvency. In this regard, facts that are relevant to the assessment include
those facts that the director ought to have known as well as those facts that were
actually known.53
Defences
There are four main statutory defences available to directors under the Corporations
Act in respect of a claim made under s. 588G. These are contained in s. 588H of the
Corporations Act and can be summarised as follows:
52
53
Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 at 702
ASIC v Plymin (No 1) (2003) 175 FLR 124 at [425]
21
•
Reasonable grounds to expect solvency
Under s. 588H(2), the director must establish the mental element of “expectation” in
relation to the company’s solvency. This is a higher standard and has been held to
require more than a mere hope or possibility.54
•
Reliance on others
A defence under s. 588H(3) can arise where a director has delegated the monitoring of
the company’s financial position to another person who is relied upon by the director.
To establish this defence, the director must prove that he or she had reasonable
grounds to believe (and did believe) that the person on whom the director relies, was a
competent and reliable person to give information about the company’s solvency.55
A further requirement is to establish that on the basis of the information provided to
the director by the reliable person, the director expected that the company was solvent
and would remain solvent. To fulfil the requirements of this defence, the court will
require a director to actually obtain the financial information from the reliable person.
It is not sufficient for the director to make no active inquiries on the allegedly reliable
person.56
•
Absence from management
If a director can establish that a “good reason” (such as an illness) prevented him or
her from managing the company at the time when the debt was incurred, s. 588H(4)
can also provide a defence to claim under s. 588G.
The courts have held that a director’s absence from participating in the management is
not sufficient reason, and hence the provision does not provide a complete defence to
a passive or lazy director.57 In Deputy Commissioner for Taxation v Clark [2003]
NSWCA 91 at [159] the Court held that the policy underpinning s. 588G was that a
54
Tourprint Pty Ltd v Bott (1999) 17 ACLC 1543 at [67]
ASIC v Plymin (2003) 175 FLR 124 at [323]
56
Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699
57
Tourprint International Pty Ltd v Bott [1999] NSWSC 581 at [75]
55
22
person should not become a director unless they were prepared to assume the
obligations and duties of the office.
•
Reasonable steps to prevent
Finally, under s. 588H(5) a director may also avoid liability if it can be established
that reasonable steps were taken by the director to prevent the company from
incurring the debt. Under s. 588H(6), matters that the Court must have regard to in
considering such a defence include the steps taken by the director with a view to
appointing an administrator.
H.
OTHER STATUTORY OBLIGATIONS
The Corporations Act imposes a number of other requirements upon directors
concerning the general operation and management of a company. A breach of these
requirements may also give rise to a breach of duty of care under s. 180(1).
Regulatory matters
Section 188(1) imposes a number of requirements upon the company secretary (or on
directors in the absence of an appointed secretary) to ensure various regulatory
matters are satisfied, including lodging notices with ASIC (s. 188(1)(d)), advising
ASIC of a change of a principal place of business (s. 188(1)(e)) and lodging financial
reports (s. 188(1)(i)).
Meetings
A director must observe the requirements concerning convening members meetings
which are contained in s. 250 of the Corporations Act. Under s. 249D directors are
under a statutory obligation to convene members meetings if they receive a valid
requisition to do so. In the event that a director fails to convene a validly requisitioned
meeting, members are permitted to convene the meeting, and the directors may be
liable for the expenses associated with convening the meeting under s. 249E(5).
23
Disclosures
A director must also observe the statutory disclosure requirements that arise in
connection with certain transactions. These are in addition to the various disclosures
that are fall under the category of the duty to avoid conflicts referred to above.
Under ss. 200B and 200C, particular retirement benefits and transfers of the business
undertaking or property must be approved by members under s. 200E. Details of the
benefit must be set out in the notice of meeting to members, in order that member
approval can be given.
In the case of a proposed share capital reduction, under s. 256D directors must ensure
that an adequate information statement is provided to members with the notice of
meeting for a capital reduction.
In the case of a scheme of arrangement, directors must comply with the disclosure
requirements provided in s. 411, including particularly obtaining and providing
accounting and solicitor reports to members and creditors under s. 411(13).
In the case of a proposed acquisition that is seeking an exemption from the prohibition
contained in s. 606 – i.e. participation in a possible breach of the 20 per cent rule directors must ensure that the members of the target company are provided with all
material information required under s. 611 item 7. In the event that compliance with
the provision is not met, the acquisition will contravene s. 606.
Directors have various obligations of disclosure for the purpose of the ASX Listing
Rules which are essentially adopted into the Corporations Act. Under s. 793C(1), if
there has been a failure to comply with the Listing Rules, ASX, ASIC or person
aggrieved by the failure may apply to the court for relief.
Financial statements and reports
A director must comply with the financial record requirements set out in Part 2M.2 of
the Corporations Act, and in particular, the requirements contained in s. 286 to keep
written and accurate financial records which correctly record and explain a company’s
financial position and performance and would enable true and fair financial statements
to be prepared and audited. Sections 287 – 289 set out the language, format and
24
storage requirements relating to financial statements. Section 344 provides that a
director of a company will contravene the provision if the director fails to take all
reasonable steps to secure compliance with Part 2M.2.
A director must also comply with the financial and director report requirements
contained in Part 2M.3 of the Corporations Act. Large private companies and all
public companies must prepare a financial report and a directors’ report each financial
year pursuant to s. 292(1). Half yearly reports may also be required in certain cases
pursuant to ss. 302 – 306. Importantly, a director must include a declaration in the
financial report pursuant to s. 295(4)(d), declaring that in the director’s opinion, the
financial statement and notes are in accordance with the Act, including compliance
with the accounting standards and the requirement that they give a true and fair view
of the company’s position.
In the case of companies other than small proprietary companies, pursuant to s. 298 a
director must give a directors’ report every financial year which contains information
including a review of the company’s operations and details of significant events
affecting the company’s operations or results. The requirements of directors’ reports
are detailed and are contained in ss. 299 – 300A.
I.
LIABILITY OF DIRECTORS
The potential consequences for a director in breach of any of the duties are significant.
The legislation prescribes penalties and sanctions which vary depending upon the type
and severity of the breach. Obviously, other general law claims may be made against
a director and actions taken as a result of breaches, including claims for injunctions,
compensation for damages and an account of profits.
A number of the statutory provisions contained in the Corporations Act will attract
the same or similar penalties if they are contravened.
Civil penalty provisions
The civil obligations of care and diligence (s. 180(1)), good faith (s. 181(1)), use of
position (s. 182(1)) and use of information (s. 183(1)) all attract civil penalties under
Part 9.4B of the Corporations Act if they are contravened.
25
Contraventions of other obligations that have been referred to will also attract civil
penalties under Part 9.4B of the Corporations Act. They include the disclosure
requirements concerning related parties (s. 209), the disclosure requirements
concerning share capital transactions (s. 256), the financial reporting and statement
requirements (s. 344) and the duty to prevent the company from trading while
insolvent (s. 588G).
In cases where the legislation is silent as to penalty, as in the case of the disclosures
concerning schemes of arrangement (s. 411) or a proposed exempt corporate
acquisition (s. 611), a contravention of these provisions may sound in a contravention
of the statutory duty of due care and diligence.
A contravention of these provisions may give rise to a declaration of contravention
under s. 1317E(1) of the Corporations Act. Under s. 1317J, only ASIC can seek such
a declaration. Under s. 206C, where a declaration of contravention has been made
under s. 1317E(1), ASIC may then apply to the court for an order seeking
disqualification of the director from the management of companies for a period that
the court considers appropriate in the circumstances.
Depending upon the degree of the contravention, the court may (on ASIC’s
application) also make a pecuniary penalty order under s. 1317G requiring payment of
a fine by the director of up to $200,000 under s. 1317G(1B). A director may also be
ordered to compensate the company in the amount of the damage that has been
suffered. In addition to ASIC, under s. 1317J a company or any other person suffering
damage may also apply for a compensation order under s. 1317H.
In relation to the insolvent trading provisions, a liquidator may bring an action under
s. 588M(2) or s. 588J(2) to join in a civil penalty action brought by ASIC for the
purpose of seeking an order that the director compensate the company in an amount
equal to the loss suffered by a secured creditor.
Other compensation provisions in the context of an insolvency
Section 588FDA of the Corporations Act provides for “unreasonable director-related
transactions”. Where there has been a payment by the company to the director (or a
close associate such as a relative or a relative of a spouse) and it is one that a person in
26
the company’s circumstances would not have entered into having regard to the benefit
and the detriment to the company of entering into the transaction (and the benefit to
the other parties to the transaction), it may fall within the ambit of the provision and
be classified as an “unreasonable director related transaction”.
In the case of such a transaction, the court can, on the application of a liquidator under
s. 588FF(1), make a variety of orders for the payment to the company of the benefit
provided by the company under the transaction, or otherwise to prevent the detriment
to the company.
Criminal sanctions
Section 184 of the Corporations Act provides for the more serious contraventions of
the statutory obligations of good faith, use of position and use of information. Under
s. 184, the director will be committing an offence where these provisions are
contravened and the conduct can be classified as reckless and intentional, and in the
case of good faith, intentionally dishonest. The provision provides as follows:
“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 intentionally 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.
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.
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:
27
(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.”
Other provisions can attract criminal sanctions where the contravention is found to be
dishonest. These include the requirement to obtain member approval (s. 209(3)), the
duty to prevent the company from trading when insolvent (s. 588G(3)), the financial
reporting and statement requirements (s. 344(2)), and the disclosure requirements
concerning share capital transactions (s. 256D(4)).
A contravention of the various regulatory requirements under s. 188(1) (such as
lodging notices with ASIC) and the disclosure requirements in connection with
financial benefits under ss. 200B or 200C can give rise to strict liability offences
under s. 188(2A) and s. 200D(2) respectively.
If any of these provisions is contravened, a director can face a criminal conviction
punishable by a penalty not exceeding the penalty prescribed under the legislation: the
various penalties are found in Schedule 3 to the Corporations Act and include a range
of monetary penalties and terms of imprisonment.
J.
CONCLUSION
This has been a relatively brief overview of some of the key duties that are imposed
upon directors under the general law and under the Corporations Act, and the
liabilities that correspond with these duties. It is hopefully clear that these duties are
extensive and complex.
There can be no doubt that the law of directors’ duties will have a significant
relevance for lawyers in the coming years. Indeed, the last year has seen the initial
phases of a number of large scale investigations being undertaken by ASIC and
liquidators in the wake of recent corporate collapses. Litigation arising from these
investigations (including actions against directors) will no doubt keep the courts
across Australia busy for a number of years to come.
28
As referred to in the introduction, ASIC appears intent on sending a message to
directors that corporate collapses (of which we have a myriad of recent examples such
as Storm Financial, Opes Prime, Timbercorp and MFS) will provoke hard questions
and potentially prosecutions.
ASIC’s hard-line approach to enforcing directors’ duties will surely affect the way
Australian directors operate and the commercial opportunities that they choose to
take, particularly where there are questions as to the solvency of the enterprise.
Directors should be increasingly aware that the decisions that they take may well
become the subject of intense scrutiny by their peers, the regulator, the media and
potentially the courts.
What is clear is that in 2010 the law relating to directors’ duties holds some pockets of
unsettled principles. Particularly in the context of the ambitious regulator, and the
current economic climate, this part of the law will surely see significant attention and
development in the years ahead.
29