Director’s Duties – a summary

Director’s duties are a series of statutory, common law and equitable obligations owed by directors to their company. These duties are a recognition that at times the interests of individual directors may diverge from those of the company and seek to ensure that director’s act with care and loyalty to the company.

Director’s duties form part of the Corporations Law, and are largely codified by Pt 2D.1 of the Corporations Act (Cth) 2001 (the Act). When a director acts in breach of one of their duties that director may become liable to pay compensation or face criminal prosecution. In practice these actions are usually pursued by ASIC but can also be instigated by effected parties on behalf of the company itself.

As directors cannot entirely remove the risk of liability attached to their actions it is important that all directors know what their duties are so that they can take steps to meet their obligations.

Duty of care, skill and diligence:

As a director you have a duty to exercise reasonable care and diligence when managing the company’s affairs.

The standard of skill that must be exercised is that degree of care and diligence that a reasonable person in a like position in a like corporation would exercises in the circumstance. This objective standard means that individual factors will not reduce the level of skill required by directors of companies. Financial competence and knowledge of business activities will be assumed. However if a director does have a particular expertise he or she will be held to a higher standard.

The Act limits a director’s right to delegate their functions and to rely on advice and information provided by employees, professional advisors, experts and other directors. Unless contrary to the company’s constitution a director may delegate powers however they will remain responsible for the exercise of that power by the delegate.

A director needs to take reasonable steps to place themselves in a position to monitor and record the management of the company and ensure that the company keeps up-to-date financial reports that meet any statutory and/or ASIC requirements.

Duty to act in good faith for the benefit of the company as a whole:

As a director you must act bona fide in the best interests of the company and for proper purposes. Generally, the best interests of the company are equated with the collective interests of the shareholders and/or stakeholders such as employees. However this may not always be the case for example in situations of near insolvency creditor’s interests must take priority.

The duty to act bona fide means that a director must act in good faith in what he or she honestly believes to be the best interests of the company.

The duty to act for proper purposes requires that a decision to exercise management power must be done for some dominant proper purpose. When a director is acting to merely secure their role within the company their actions are likely to be considered improper. For example issuing shares to raise capital is a legitimate proper purpose however issuing shares to defeat a takeover bid or to dilute the voting power of certain shareholders are improper purposes.

Fiduciary duty to avoid conflicts of interest:

As a director you have a duty to avoid conflicts of interest and not to profit from your position.

Under the duty to avoid conflicts directors and other officers must avoid putting themselves in positions where they may be tempted to prefer their own interests or someone else’s interests to those of the company. This is applied strictly and a director may become liable even if they act honestly and do not stand to make a profit.

The Corporations Act requires that a director who has a material personal interest in a business matter of the company give notice of the conflict to the other directors. If this is done diligently liability will be unlikely to flow. However there are exceptions to this duty to disclose in the Act.

Under the duty not to profit a director who profits from using company information or their position will be required to pay these profits back to the company. This is also applied strictly not requiring any element of fraud or detriment to the company. Mere profit will be enough to breach this duty however detriment to the company will also suffice.

Specific statutory duties – Insolvent Trading:

Section 558G of the Act imposes a duty on directors to prevent insolvent trading. The company is ‘insolvent’ if it can’t pay its debts as they become due and payable.

As a director you would be breaking the law if you let the company trade while insolvent. A liquidator or creditors can sue you personally for your own assets, not just the assets of the company, and you can face criminal prosecution.

You must stop the company from trading if it is unable to meet its existing debts.  If you have reasonable grounds to suspect the company cannot meet its debts, or won’t be able to if you take on more debt, you need to seek professional advice.