Week 5

Question 1

Key Duty of directors

Answer 1

Main duty is to act with loyalty and in good faith (be a fiduciary). Act in good faith in the interest of the company
Act for a proper purpose
Retain discretions
Avoid a conflict of interest

Question 2

Duties arise under:

Answer 2

Common Law
Directors (all types)
Senior executive officers
Managers
Senior officers

Statute (Corporations Act)
Directors (all types)
Other company officers
Employees ( s182 and 183)

Question 3

Historical rationale for the two sources of duties

Answer 3

Common Law: director as fiduciary, private loss.
When the company is affected, it wants compensation or damages
The company wants to take action against the director

Statute Law: public loss.
Under the Corporations Act the Regulator (ASIC) wants to take action against the director
If the actions of the director are so bad then the Regulator feels they should take action then the penalties include:
– Civil Penalty/Fine
– Disqualification
– Imprisonment

Question 4

Overall obligation of being a fiduciary

Answer 4

Directors, officers and senior managers are have a common law a duty to act in best interest of the members and the company (called a fiduciary obligation)

“ the fiduciary undertakes to act for or in the interests of another person in the exercise of a power or discretion which will affect the interest of the other person. Because the fiduciary can exercise power to the detriment of the person to whom they owe a duty and the person is at the mercy of the fiduciary that the fiduciary comes under a duty to exercise his power in the interests of the person to whom it is owed”
Hospital Products Ltd v United States Surgical Corp (1984) 156 CLR 41

Question 5

Loyalty

Answer 5

A fiduciary a duty of loyalty to the company
To show loyalty a person must:
Act in good faith
Not make a profit out of his position
Not place themselves in a position where his duty and his interest conflict
Not act for their own benefit or a third person without the informed consent of the principal
Retain their discretionary powers
Note: that many of these common law principles have been put into the legislation see s 180.

Question 6

Duties at common law

Answer 6

Main duty is to ensure the loyalty and good faith of the directors to their company and protect the interest of the members (fiduciary obligation)
These interest can diverge so case law has developed principles over the years
Minimum standards of all directors:
be familiar with company’s business and financial position
monitor management
Inquire and seek information
cannot ignore corporate misconduct

Question 7

Under the general description of fiduciary duty:

Answer 7

Under the general description of fiduciary duty:
Duty to retain discretions
Duty to avoid conflicts of interest
Duty to act in good faith in the interests of the company
Duty to use powers for a proper purpose
Duty to act with reasonable care and diligence
Note: that there is an overlap between the statute and case law on duties

Question 8

Statutory duties for directors

Answer 8

S 180 act with reasonable care and diligence
S 181 act in good faith in the best interests of the company and for a proper purpose
S 182 not to misuse position
S 183 not to misuse information
S 588G prevent insolvent trading
S 191 disclose certain interests
S 194 disclose to other directors and vote (proprietary companies)
S 195 disclose and not able to vote (public companies)
Chapter 2E avoid related party transactions

Question 9

The duty of care can arise from

Answer 9

Contract between the director and the company (law of agency)
The general law
At common law directors owe a duty to their companies to exercise reasonable care, otherwise they will be held to be negligent and therefore liable for breach of duty
s 180 of the Act (extracted later)

Question 10

Who are the duties owed to?

Answer 10

The company
Key case: Percival v Wright [1902] 2 Ch 401
Facts: Shareholders in Nixon’s Navigation Co. wanted to sell their shares, and requested that the company’s secretary find purchasers. Some directors of the company purchased the shares at £12.10s per share, which price was based upon independent valuation. After the sale, the shareholders discovered that before and during the negotiations for that sale, the board of directors had been involved in other negotiations to sell the entire company, which would have made those shares substantially more valuable. The plaintiff sued, claiming breach of fiduciary duty, in that the shareholders should have been told of these negotiations.
Court held that: The shareholders were unsuccessful. The directors owed duties to the company and not shareholders individually.
The members
Key case: Brunninghausen v Glavanics (1999) 17 ACLC 1247
Facts: B & G were directors and shareholders of a company that imported ski gear. B held 5/6 of the shares and G one. G took no part in the management of the company . B & G had a dispute and it was agreed that G would sell his shares to B and resign as a director. B did tell G that B had been approached to sell the company to a third party. G sold his shares to B and then B sold all the shares at a profit.
Court held that: B & G were in a fiduciary relationship. B has an advantage over G and owed a duty of care to G and breached his duty to G when he did not disclose to G the negotiations to sell the company.

Question 11

How does court determine a if director has breached the duty of care?

Answer 11

Court look to the actual amount of care and diligence exercised by the director and compares this with the degree of care and diligence that a reasonable person would exercise if they were a director of a similar company and had the same responsibilities as the director (reasonable person test)
Under general law where a director is held to owe a duty of care to their companies they will be held to be negligent and in breach of duty
There is no difference between the statute law duty and the common law duty – the difference is in the application of penalties

Question 12

What is the standard?

Answer 12

Care
Exercise reasonable care
Skill
Must have basic skill to understand the business of the company and its financial status
Depends on type of directors
1. Executive
Standard is tested against what a reasonable person in the same position would do
2. Non-Executive Director
If have a special skill then if there is a breach is tested by referring to the knowledge and expertise possessed by other people with the same skill and expertise
3. Chairman
Higher standard than minimum, responsibilities include overseeing general performance of board, flow of financial information to board (see: ASIC v Rich)
4. Managing Director/CEO
have overall responsibility for day-to day management of company’s business (see: ASIC v Adler)

Question 13

The court said that the minimum standards are:

Answer 13

A director must acquire basic understanding of the business and be familiar with the fundamentals of the business
The must keep informed about the activities of the Company
Detailed inspection of the day to day activities is not required, only a general monitoring of the company’s business affairs – therefore attend board meetings regularly
Be familiar with the financial status of the company by reviewing financial statements
Directors can make business decisions but they can not do so in ignorance and a failure to enquire are no defence
Can not ignore any misconduct of the company
If have a particular skill then must also pay attention to other areas of the company

Question 14

Responsibility for actions of delegates s190

Answer 14

When directors delegate then they are responsible for the exercise of the power by the delegate
S 198D allows the directors to delegate to:
A committee of directors
A director
An employee
Any other person
Must record delegation in minute book (s 251A)
S 190 provides that director will not be liable for the actions of a delegate if the director had:
reasonable grounds,
acted in good faith, and
made proper inquiries,
that the delegate was reliable and competent in relation to the power delegated.

Question 15

The first statutory duty of directorssection 180(1) – care and diligence

Answer 15

Section 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 section1317E).

Question 16

Defences to breach of the duty of care?

Answer 16

Business Judgement Rule
The courts will not review the merits of management decisions. The courts will only look at the reasons and actions of the directors incoming to that decision. Not all decisions are correct.
What the courts are concerned about is the basis in which the directors came to the decision (i.e. process not outcome).
Among other factors, the director must rationally believe that the judgment is in the best interests of the company. This believe will be a rational one unless the belief is one that no reasonable person in their position would hold.
A rational belief exists if the director believes that his judgement was in the best interest of the company and that belief is supported by a reasoning process that is rational (i.e. must be able to justify his actions) (ASIC v Rich)
This defence only applies where a breach of duty of care in s 180, or the equivalent duty at common law.

Question 17

The statutory business judgement rule section 180(2)

Answer 17

(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.

Question 18

ASIC v Rich set out the following principles/relevant factors when applying the defence:

Business judgment rule

Answer 18

The director must inform themselves about the subject matter of the judgement to the extent they believe reasonably appropriate
The importance of the business judgement to be made
The time available to obtain the information
The cost of obtaining the information
The director’s confidence in exploring these matters
The state of the company’s business at the time
The competing demands on the board’s attention
Whether the material information is reasonably available to the director

Question 19

What are the consequences of breaching a duty of care?

Answer 19

If a breach of statutory duty (s 180):
Civil penalty provisions enforced by ASIC
ASIC can ask the Court to
Disqualify person from managing companies
Pay penalty of up to $200k,
Pay compensation to company for loss or damage because of breach of duty
If breach of common law duty:
The duty is enforced by the company
Company can ask for:
Compensation
Damages

Question 20

The duty of care to prevent insolvent trading: s 588G

Answer 20

(particularly unsecured creditors)
Applies only to directors (including de facto and shadow)

The elements set out in s 588G(1)&(2):
The person is a director when
The company incurs a debt and the company is insolvent when it incurs a debt or
Becomes insolvent because it incurs the debt and
When it incurs the debt there are reasonable grounds for suspecting the company is insolvent or a reasonable person would be so aware;
The director fails to prevent the company from incurring the debt.

Question 21

When will a debt be incurred?

Answer 21

Deemed debts (see s. 588G(1A)) e.g. paying a dividend –debt is incurred when the dividend is paid
Debt can be contingent i.e. based on existing obligation but debt to be paid some time in the future e.g. a guarantee
Debt must be for a specific amount
Debt must be incurred voluntarily or by operation of law
Tax due on wages are a debt when deduction made by employer under s 588F

Question 22

When is a company insolvent?

Answer 22

Section 95A provides that:

(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.

Insolvent:
unable to pay its debts as and when they fall due.
Apply the “cash flow” test.

Question 23

Reasonable grounds of suspecting insolvency

Answer 23

Directors must have reasonable grounds for suspecting insolvency.
“a positive feeling of actual apprehension and not mere speculation” (Queensland Bacon Pty Ltd v Rees)
Court will look at whether a director has a basic understanding of the company’s financial status

Refer back to duty to understand financial statements

Question 24

Aware

Answer 24

Director was aware at the time the debt was incurred there were reasonable grounds to suspect the company was insolvent
A reasonable person would have suspected
A reasonable person is a director of ordinary competence (see minimum requirements of a director)

Question 25

The 4 defences to breach of s 588G:

Answer 25

Section 588H
Director had reasonable grounds to expect the company to be solvent:
Based on own knowledge (s 588H(2));or
Reasonable reliance on information supplied by another person (s 588H(3)) (NB: see previous principles of delegation/reliance);or
Due to illness or some other good reason being absent from management (s 588H(4);or
Director did take all reasonable steps to prevent company incurring debt (s 588H(5)).

Question 26

Insolvency of subsidiary companies

Answer 26

Section 588V provides that a holding company has duty to prevent subsidiary from trading whilst insolvent.

Question 27

Contravention of s 588G

Answer 27

Compensation
Civil penalties
Criminal offence under s 588G(3) (if failure to prevent the company incurring debt is dishonest)
Note:
Compensation is the amount of the loss or damage suffered by the creditors. Claim is mainly by unsecured creditors.
Liquidator or individual creditor can take action to recover money
ASIC can also take action
Disqualification
Fine
Compensation to company

Question 28

Duty to act in good faith in the interest of the company

Answer 28

Duty arises under equity – fiduciary duty – where directors have a fiduciary obligation to act in good faith.

Test for breach of duty:

“[A breach will occur] where on consideration of the surrounding circumstances the statement that the directors acted in good faith in the best interests of the company and for a proper purpose should not be accepted….The court may intervene if the decision is such that no reasonable board of directors could think the decision to be in the interests of the company.”
	Bell Group v Westpac banking Corporation (No. 9) [2008] 	WASC 239

Question 29

“Best interests of the company”..

Who could this represent?

Answer 29

Company
Members
Creditors
Employees
Group companies
Corporate responsibility (corporate governance)

Question 30

Members

Answer 30

Interest of members and the company generally coincide but interest of the shareholders are paramount
Must act in the best interest of the shareholders as a collective group
May need to consider present and future shareholders as well as the company on basis that the company is a going concern (Darvall v North Sydney Brick & Tile Co Ltd)

Question 31

Other issues about members

Answer 31

What if the company has different classes of shares?
What is fair between the classes of shareholders
If a class of shareholders are affected then can apply under s 232 for oppression (see Mills v Mills; see further in members remedies topic)
Are duties owed to individual shareholders?
Do not owe duty to a particular shareholder but to company as a whole: Percival v Wright
Owe a duty to a shareholder where director in close and direct contact with the individual so that the director caused the member to act on it which was detrimental to the member: Brunninghausen v Glavanics
What about nominee directors?
They represent interest of a particular group and must act honestly and reasonably believe that there is no conflict between the interest of parties they represent and the interest of the company
(Key case: Scottish Co-operative Society v Meyer).
Nominee directors of a holding company failed to look after interest of the company over the interest of the holding company. The holding company by not supplying yarn to the subsidiary company caused the shareholders of the subsidiary to go broke.
Recent Australian case say nominee directors must act in interest of the company and not nominee where a conflict.

Question 32

Creditors

Answer 32

Where a company is solvent the best interest of the company are the best interest of the shareholders.
Where a company is insolvent then the best interest of the company are the interest of the creditors
Directors must not do anything that prejudices the ability to pay creditors (duty in section 588G)
Power of creditors to enforce interests:
s 588R and s 588T creditor can sue for recovery with or without consent of liquidator
Antecedent transactions can be reversed (see Topic on Insolvency)

Question 33

Employees

Answer 33

Common Law: Directors should not consider the interest of the employees at the expense of the shareholders
Key Case: Parke v Daily News Ltd [1962] Ch 927
Company sold a newspaper and the directors intended to distribute the surplus to employees as compensation for dismissal. Shareholder objected.
The Court held that payments were not incidental to the carrying on of the business and were gratuitous and to the detriment of the shareholders and the company. Payment to employee only in interest of the company if the employment continues.
Statutory Law: Corporations Law Amendment (Employee Entitlements) Act 2001 Pt 5.8A protects the entitlements (wages, superannuation, redundancy, personal injury compensation, etc.) of a company’s employees from agreements and transactions that are entered into with the intention of defeating the recovery of those entitlements.

Question 34

Corporate groups: common law

Answer 34

Appointment of nominee directors: If a conflict between interest of subsidiary and the group, nominee directors must act in subsidiary’s interest and not in the interest’s of the group as a whole (Walker v Wimborne and Industrial Equity Ltd v Blackburn)

No breach of duty if the actions show that the subsidiary will benefit from the assistance given to other companies in the group (Equiticorp Finance Ltd v Bank of New Zealand)

Question 35

Wholly-owned subsidiaries: statutory law

Answer 35

Section 187
Directors of wholly-owned subsidiaries
A director of a corporation that is a wholly-owned subsidiary of a body corporate is taken to act in good faith in the best interests of the subsidiary if:
The constitution of the subsidiary expressly authorises the director to act in the best interest of the holding company; and
The director acts in good faith in the best interest of the holding company; and
The subsidiary is not insolvent at the time the director acts and does not become insolvent because of the director’s act.
Directors of not wholly-owned subsidiaries
Generally directors need to view the interests of the group, the minority shareholders and the subsidiary shareholders.

Question 36

For a proper purpose: s 181

Answer 36

Duty to exercise powers for a proper purpose is a fiduciary duty.

“Directors of a company are fiduciary agents, and the power conferred upon them cannot be exercised in order to obtain some private advantage or for any purpose foreign to the power.”
Dixon J in Mills v Mills

Statutory Duty
Recall, section 181 requires directors to discharge their duties:
In good faith in the best interests of the corporation
For a proper purpose

Good faith–civil obligations (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:This subsection is a civil penalty provision (see section1317E).
Note 2:Section187 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:Section79 defines involved .
Note 2:This subsection is a civil penalty provision (see section1317E)

Most cases on this relate to share issues by directors
If found to be improper then the share issue is invalidated
Explored further in Corporate Finance and Members’ Remedies topics.

Examples: 
 Proper purpose to issue shares if it involves:
raising capital, 
employee incentive schemes, 
for acquisitions 
Improper purpose 
Retain control
Deprive shareholders of rights

To ascertain whether there is a breach, the Court will look at:
What is the particular power in question and what are the legal purposes for which this power may be used.
The court will then look at the facts of the case and the intentions of the director to decide what was the actual purpose the director exercised his power
In summary the courts look at why the director what they did and see if there was a lawful reason for what they did.

Question 37

Examples of proper purpose

Answer 37

Examine facts to determine directors’ actual reason or purpose for exercising the particular power.
Involves looking at:
the substantial purpose for the exercise of the power
(Howard Smith Ltd v Ampol Petroleum Ltd) tried to reduce to a minority position members who had a majority of shares in the company
whether the main purpose was improper
(Whitehorse v Carlton Hotel Pty Ltd) tried to entrench control of the company in certain shareholders by issuing them more shares
Commercial justification
(Pine Vale Investments Ltd. v McDonnell and East Ltd) change in valuation of share offer due to change in valuation of target company

Question 38

Examples of improper purpose

Answer 38

Maintain management control (Ngurli v McCann)
Eliminate existing majority (Howard Smith case)
Defending hostile takeovers
Using funds to promote re-election of directors (Advance Bank Australia v FAI Insurance Ltd)
Exercise powers for the benefit of others (The Bell Group Ltd case)
Exercise of management powers (Permanent Building Society v Wheeler) enter contract to have company buy property to assist another company that 2 directors had financial interest in

Question 39

Mixed purposes

Answer 39

Directors may be motivated by a number of purposes, some proper, some improper, to issue shares.
‘But-for’ test: (Darvall, Whitehouse)
Consider: “But for the alleged improper purpose, would the directors have performed the act impugned?”

Question 40

Consequences of breach of duty

Answer 40

Breach of s 181 is a civil penalty provision and enforced by ASIC see ss. 1317E, 1317G
Civil remedies
damage
rescission
Civil penalties
Disqualification 
Civil penalty 
Compensate the company (section 1317H)
Criminal offence (section 184)
Where breach is reckless or dishonest 
Imprisonment (15 years)

Question 41

Penalties – Individual

Answer 41

Civil Pecuniary Penalty
The greater of:
5,000 penalty units ($1,050,000); or
if the court can determine the benefit derived or detriment avoided because of the contravention, multiplied by three.

Question 42

Civil Penalties – Factors

Answer 42

In determining the pecuniary penalty, the Court must take into account all relevant matters, including:

(a) the nature and extent of the contravention; and
(b) the nature and extent of any loss or damage suffered because of the contravention; and
(c) the circumstances in which the contravention took place; and
(d) whether the person has previously been found by a court (including a court in foreign country) to have engaged in similar conduct.