Incorporating your business is a huge step as a small business owner. However, becoming a director also means that you have duties under the Corporations Act 2001 (Cth) (‘CA’) to follow! Not only should you follow these duties to protect your business, but also to avoid personal liability. In this article, we look at some of your directors’ duties in Australia and the consequences for breaching them.
This post is the first of a series of posts covering Directors’ Duties.
Acting in Good Faith and for a Proper Purpose
This duty comes from s 181 of the CA. We can break it down into two parts: good faith and proper purposes.
Good faith
A director must carry out their duties in ‘good faith’ and ‘in the best interests’ of the corporation. But what does good faith and best interests mean?
The ‘best interests’ of the company generally refers to the company’s shareholders’ financial interests as a whole. Your shareholders want to see the company do well so the value of their shares go up, so anything that a director thinks will help the value of the shares increase may be considered in the best interests of the company. However, legislation and your company constitution can also influence your company’s ‘best interests’.
Good faith is assessed subjectively. If the director genuinely thought that their actions were in the best interests of the company without ulterior motives, then they can be said to have abided by this section. However, there are two issues with this. One is that sometimes actions can hurt the company even if the director had good intentions. The second is that if there is only a subjective test, then a director can just lie that they were acting in good faith when they were not.
Therefore, a secondary objective test might also apply. A director may be contravening s 181 if:
- The director is acting in a way that no reasonable director in their position would act, or
- There are surrounding circumstances that indicate that the director’s assertion is not entirely true.
Proper purpose
Directors are also required to carry out their duties for a proper purpose. This refers to the power of a director and whether the director used their power in a way that follows the purpose of that power. For example, a director generally has the power to issue shares. This power to issue shares was given for purposes such as raising capital or ensuring the company has the required number of directors per the CA.
However, it may be improper to use this power to issue shares if it is motivated by:
- Maintaining control of company’s majority shareholders; or
- Defeating a takeover bid; or
- Diluting voting power of certain shareholders
This is not an exhaustive list, and what is considered ‘proper’ and ‘improper’ will vary based on your individual circumstances.
In some cases, directors may act with both proper and improper purposes. If the director would not have done the action without the improper purpose, they may still contravene s 181.
Consequences of breaching s 181
There are a range of consequences that may apply if a director breaches s 181, including:
- Fines and penalties
- Compensating the affected party for loss caused by the breach
- Imprisonment
- Disqualification to prevent the director from being a director for a period of time.
Due Care, Skill and Diligence
Section 180 says that directors ‘must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise’ in their position at their company.
What this section requires is that the director fulfil their duties to the corporation to a sufficient standard. For example, as directors have a duty to take reasonable steps to guide and monitor the management of the company, it means that their responsibilities also extend to all the tasks necessary to fulfil that duty. This includes understanding how the business works, staying informed about the company’s activities, monitoring the company’s activities through attending board meetings, and staying informed about the company’s financial statements.
Just because a director is inexperienced in running a business or understanding financial statements, doesn’t mean that they are exempt from s 180. The courts have held that they expect directors to learn how their business works and how to read its financial statements, because those are reasonable steps in guiding and monitoring a company as its director.
What the director’s required standard of care and diligence is, and whether they’ve met that degree, will differ based on the situation.
A director can face fines or disqualification for breaching this duty.
Retaining Discretion
Under equitable law, a director cannot limit their decision-making unless it’s otherwise authorised by the company constitution or the CA.
For example, if a director’s votes only ever followed another person’s direction when voting at board resolutions, that may be an example of ‘fettering the first director’s discretion’. However, so long as the director has thought carefully about their decision and is making it in good faith for the best interests of the company, they might still bind themselves to act a certain way in the future.
The consequence of breaching this duty will greatly differ depending on the circumstances of the case. For example, if a director agreed to follow another person’s direction when voting, there could be many factors to consider when deciding the consequence, including:
- You don’t want the director to keep following that person’s directions, so you might seek an injunction against them to stop them from doing so.
- You or the company might have suffered loss from that director fettering their voting discretion, and might want compensation.
- The director might have received payment for following the direction of the other person, and you might want to receive that payment instead.
What Next?
A lot goes into being the director of a small business. Making sure you understand your responsibilities as a director can help you avoid liability and keep your company safe. Consulting an experienced lawyer about your director’s duties can give you peace of mind when running your business.
This is part one of our posts on directors’ duties, so keep an eye out for part two!
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