Module 8

Directors’ and
officers’ duties
A
 Module overview

1. Duties and obligations of directors and officers

2. Directors’ duty of care and diligence
3. Standard of care
4. Requirements of diligence
5. Defences against breach of care and diligence
6. Duty to avoid insolvent trading
 Officers’ duties

• Members cannot interfere with the management of a

company.
• Directors’ and officers’ must act in the best interests
of the company (its members) under:
– common law
– the Corporations Act
– the employment contract.
 Officers’ duties

• Key duties of an officer:

– Act with care and diligence
– Avoid allowing the company to trade whilst
insolvent (a directors’ duty only)
– Be a fiduciary
 Officers’ duties

• Key duties of an officer:

 General law duties

• Under common law, officers have a duty to:

– be a fiduciary:
• avoid conflicts of interest
• act in good faith in the interests of the
company
• use their powers for a proper purpose
– act with reasonable care and diligence.
 General law duties

• Under an officer’s common law fiduciary obligation to

the company, they:
– owe a duty of loyalty:
• act in good faith
• not make a profit out of their position
• not place themselves in a position where their
duty and their personal interest conflict
• not act for their own benefit or benefit of a third
party without the informed consent of the
principal.
 General law duties

• Under an officer’s common law fiduciary obligation

to the company, they:
– must retain discretions:
• act in the best interests of the company as a
whole, not in the particular interests of a
controlling or influential shareholder.
 General law duties

• Under an officer’s common law duty to act with

reasonable care and diligence, they must:
– be familiar with the company’s business and
financial position
– monitor management
– enquire and seek information
– not ignore corporate misconduct.
 Statutory duties

• Under an officer’s statutory duties, they must:

– act with reasonable care and diligence
– prevent insolvent trading
– act in good faith in the best interests of the
company and for a proper purpose
– not misuse their position
– not misuse information
– disclose certain interests
 Statutory duties

• Under an officer’s statutory duties, they must:

– disclose interests and vote (in a proprietary
company)
– disclose interests and not vote (in a public
company)
– avoid related party transactions.
 Breaches of duties

• ASIC will take action against an officer in breach of

their statutory duties if is is deemed of sufficient
public interest.
• The company, members or other officers can use the
common law to take legal action in response to a
breach. The action will usually seek damages.
• The company can take legal action against an officer
if they breach their contract.
 Breaches of duties

• Actions for a breach of an officer’s duties:

 Remedies

• As a remedy for a breach, a company can seek:

– compensation
– damages.
• As a remedy for a breach, ASIC can seek:
– a fine (either criminal or civil)
– disqualification
– imprisonment.
 Duty of care and diligence

• Duty of care and diligence arises from:

– a contract between the director and the company —
s 140(1)(b)
– the common law
– the care and diligence provisions of the Corporations
Act — s 180.
• Duty of care and diligence is owed to:
– the company (i.e. the members as a whole)
– in certain circumstances, also to particular members.
 Duty of care and diligence

• Brunninghausen v Glavanics (1999) 17 AC LC 1,247:

 Reasonable person test

• To determine a breach of the duty of care and

diligence, the court will apply the reasonable person
test:
– The court compares the care and diligence a
reasonable person would have exercised in the
officer’s position with the actual amount of care
and diligence exhibited by the officer.
 Penalties

• For a breach of the duty of care and diligence:

– the company can seek damages
– ASIC can ask the court to:
• disqualify the person
• impose a penalty of up to $200 000
• order compensation to be paid to the company
• There are no criminal penalties under the
Corporations Act for a breach of this duty.
 Standard of care

• A minimum standard of care expected of different

types of officers has been established in case law.
• Directors are expected to:
1. acquire a basic understanding of the business and
be familiar with the fundamentals of the business
2. stay informed about the activities of the company
3. delegate only to capable, experienced, qualified,
reliable persons
 Standard of care

• Directors are expected to:

4. be familiar with the financial status of the
company by reviewing financial statements
5. make sufficient enquiries to inform business
decisions
6. not to ignore any misconduct of the company
7. pay attention to all areas of the company.
 Expectations of different
types of directors

• Executive directors are involved in the day-to-day

running of the company and are expected to have a
higher level of skill.
• Non-executive directors are often appointed for
some particular expertise, but are not immersed in
the day-to-day running of the company.
 Expectations of different
types of directors

• Executive directors are expected to exhibit a higher

standard of care than non-executive directors.
• The chair and the managing director/chief executive
officer are subject to relatively high standards of
care.
 Standard of care

• ASIC v Adler (2002) 20 AC LC 1,146:

 Diligence

• The duty of diligence requires officers to:

– understand the affairs of the business
– take proactive steps to be informed
– seek professional advice as necessary
– pose issues and questions on matters before the
board.
• In delegating responsibilities, an officer must have
reasonable grounds to believe the delegate will
exercise the delegated powers properly.
 Delegation

• Principles and issues in delegation:

 Diligence

• A director is able to rely on information and advice

provided by others (s 189) as long as:
– for an employee — the director has reasonable
grounds to believe the employee is reliable and
competent
– for a professional expert — the director believes
that the expert has the skills required
 Diligence

• A director is able to rely on information and advice

provided by others (s 189) as long as:
– for another director — the director believes the
other director has the skills required
– for a committee — the director believes the
committee has the skills required.
 Defences against a breach
of care and diligence

• Business judgement rule:

– A defence in common law and statute that relies
on the principle that the court will not review the
merits (good or bad) of a business decision.
– The rule recognises that managers operate in an
environment of uncertainty.
 Defences against a breach
of care and diligence

• The court will look at:

– why the officers took a particular action
– whether the action was intended to benefit the
company or intended to benefit the directors
– the level of experience and knowledge of the
officer making the decision.
 Business judgement rule

• Criteria to use the business judgement rule defence:

 Duty to prevent
insolvent trading

• A company is insolvent when it cannot pay its debts

as and when they fall due.
• Section 588G of the Corporations Act imposes a duty
on directors to prevent insolvent trading.
• The duty is designed to protect unsecured creditors.
• If directors allow a company to trade whilst insolvent
and the company enters liquidation, the directors
may be held personally liable for the company’s
debts.
 Duty to prevent
insolvent trading

• Contravention of duty to prevent insolvent trading:

 Duty to prevent
insolvent trading

• For a breach to occur, reasonable grounds must have

existed for the director to suspect insolvency.
• In order to prevent trading whilst insolvent and in
order to avoid breaching the duty, directors must be
familiar with the company’s financial position and
able to understand the company’s financial
statements.
 Insolvent trading
defences

• To defend a breach, a director must have had

reasonable grounds to expect the company was
solvent:
– based on their own knowledge, or
– based on reasonable reliance on information
supplied by another person, or
– have been absent due to illness, or
– have taken all reasonable steps to prevent the
company incurring debt.
 Insolvent trading
penalties and remedies

• Penalties and remedies for a breach:

– compensation to ensure creditors are paid
– civil penalties imposed on directors
– criminal sanctions for serious offences and where
dishonesty is involved
– disqualification of the directors.
 NEXT

Module 9

Directors’ and officers’

duties B