The Common Law Obligations Pertaining to Directors - Essay Example

LAW1300 COMPANY LAW 01 2015 ESSAYASSIGNMENT (DUE MONDAY WEEK 9) The duties of directors under the Corporations Act An essay by __________________________ (your name) TABLE OF CONTENT 1.0 Introduction 2 2.0 Background 3 3.0 Duty of care and diligence 3 3.1 Duty of care 4 3.2 Business Judgement Rule 5 4.0 Duty to prevent insolvent trading 5 4.1 Defences against insolvent trading 6 4.2 Statutory Law v Common Law 6 5.0 Duty of good faith 8 5.1 Discharging duties in best interests of the corporation 8 5.2 Conflict Situations 8 6.0 Duty to disclose a material personal interest 9 6.1 Duty not to gain an advantage or cause detriment 9 6.2 Duty not to make improper use of information 10 7.0 Analysis – Duty to Prevent Insolvent Trading 10 7.1 Regulation of directors’ duties 11 7.2 Common law Developments 12 8.0 Conclusion 12 9.0 End References and Table of Cases 14 1.0 Introduction The main aim of this work is to scrutinise the essential statutory and fiduciary duties of directors and the burden placed upon them by the Corporations Act 2001, and the common law. The Corporations Act 2001 specifies the duties of directors. Some of these being the duty to exercise reasonable care and diligence, which has been stipulated under Section 180 of this Act; and the Section 181 requirement to conduct the company activities with good faith and legitimate purpose. In addition, several fiduciary duties are in place, such as the Section 182 duty to avoid conflict of interest, and the Section 183 requirement to abstain from misusing confidential information[Psa08]. Moreover, this Act at Section 184, attaches criminal liability for directors. Thus, Section 588G of this Act renders a director criminally liable for insolvent trading, while Section 1043A holds a director criminally liable for engaging in insider trading[Bar133]. In addition, by means of the statutory derivative action, individual shareholders can bring an action on behalf of the company. This is with regard to a breach of duty by an officer or director, in instances, wherein the company is either unable or unwilling to initiate such action. An individual enjoys the necessary standing for bringing a derivative action, when he is a member, former member or person entitled to be registered as a member of the company, officer or former officer of the company. In addition, such individuals should have obtained the court’s permission, as required under Section 237 of the Act[Bla06]. 2.0 Background Australian law imposes several duties upon the directors of incorporated companies. These are a consequence of the Corporations Act 2001, and other Federal or State legislation, common law and equity. A breach of these duties can render a director liable for criminal sanction, civil liability, regulatory investigation or disqualification from office. The company, its liquidator, creditors, corporate regulator, or the ASIC can initiate proceedings against a director for such breach of duty[Yel08]. As such, director duties have also been based upon judge-made law. Thus, in Re City Equitable Fire Insurance Co Ltd, the presiding judge defined the duties of directors in relation to diligence, honesty, and skill. Statutory force was accorded to duties in like terms, only with the advent of the Companies Act 1958. This provision required directors to act honestly and to employ reasonable diligence during the discharge of their duties[Hay14]. Such honesty and diligence had to be exercised at all times. 3.0 Duty of care and diligence Sections 180 and 181 of the Corporations Act 2001, specify the duties of the directors of a corporation. Section 180 of this Act stipulates that the officers of a company have to exercise the same care and diligence that a reasonable individual would have exercised, upon being placed in similar circumstances[Cas061]. As such, the duties of care and diligence, and of good faith have existed from decades. In addition, the presence of statutory prohibitions regarding certain forms of commercial conduct has become a matter of course. Some of these being the prohibitions related to the different voidable transaction provisions of Sections 588FA to 588FJ of the Corporations Act 2001. Specifically, the provisions pertaining to uncommercial and insolvent transactions, and unreasonable director-related transactions have become familiar[Hay14]. As such, in ASIC v Healey & Ors [2011] FCA 717 (Centro case), the directors were held liable for having failed to exercise their Section 180(1) duty of care and diligence, and for having approved inaccurate accounts. These directors were also accused of having failed to exercise their statutory duty of care and diligence, with respect to compliance with financial reporting, as specified under Section 344(1), and omission in classifying an amount as short-term liability, as required by Section 601FD(3). Although, directors cannot be held responsible for unanticipated risks, they have to necessarily peruse and comprehend the financial statements of their company[Bar133]. In James Hardie Industries NV v ASIC, the board of directors of the plaintiff company was charged with having failed to act with the required care and diligence. In addition, the directors of this company were found to have breached their duties by sanctioning a company release of a misleading statement to the stock exchange[Bar133]. 3.1 Duty of care The standard of care required of a non-executive director is lower than that of an executive director. The general idea is that the directors of a company have to adopt reasonable measures, so as to supervise and direct the management of the company. As such, non-executive, as well as executive directors are under a duty of are to act in the best interests of the company. The factors to be considered, in this regard, have been specified in the ruling in ASIC v Adler[Pea13]. In addition, the ruling in ASIC v Healey and ASIC v MacDonald, limit the circumstances under which the directors of a company can rely upon the advice provided by specialists, and this extends to even the specialist matters[Wan15]. These cases involved non-delegable duties of care, which had been imposed by legislation on the directors. 3.2 Business Judgement Rule Nevertheless, the Business Judgement Rule provides significant protection to directors. This is available under Section 180(2) of the Corporations Act 2001, and has been the object of discussion in ASIC v Adler. The sum and substance of this rule is that the courts will exhibit reluctance to pronounce a judgment, on the merits of the decision of a director, when that director makes the same under the following conditions. First, the decision is in good faith for a legitimate purpose. Second, the director does not have a material personal interest in the issue. Third, the director obtains the information regarding the issue, to the extent that he reasonably believes to be fitting. Fourth, the director believes rationally that his decision promotes the best interests of his corporation[Pea13]. 4.0 Duty to prevent insolvent trading Moreover, it is incumbent upon the directors of a corporation to prevent it from engaging in insolvent trading. This has been deal with under Section 588G of the Corporations Act 2001, and it applies solely to the directors of a corporation. This Section comes into effect when the following conditions are in place. First, when an individual is a director at the time of incurring the debt by the company. Second, the company, at the time of incurring the debt, should have been insolvent. Third, there should have been reasonable grounds to conclude that the company was insolvent at the time of its incurring the debt. Finally, these reasonable grounds should have been in existence, from the time of implementation of this Section[Tom02]. 4.1 Defences against insolvent trading Some of the defences available to directors, with respect to the infringement of Section 588G of the Corporations Act 2001 are enumerated in the sequel. A defence is available under Section 588H of this Act, if it can be established that at the time of incurring the debt, the concerned director had reasonable grounds to believe that the company was solvent. In addition, there should have been reasonable grounds to believe that the company would continue to be solvent, even after it had incurred the debt. The ruling in Metal Manufacturers Ltd v Lewis described these reasonable grounds as follows. These were the facts and circumstances actually in the knowledge of the defendant, given his position in the company and the duties related to that position[Tom02] 4.2 Statutory Law v Common Law The principal duties of directors, stipulated under the Corporations Act 2001 are; first care and diligence, which requires them to exercise the care and diligence expected of a reasonable person in the same situation. Directors are protected by the business judgment rule, with respect to a claim at common law or under Section 180. Second, directors have to act in good faith and in the best interests of the company for a proper purpose. Under this duty, directors have to avert conflicts of interest, disclose the same and manage them. This is a fiduciary duty imposed upon directors by legislation and the general law[Aus1]. This is the gist of Section 181 of the Act. Third, Section 182 of the Act, enjoins that directors have to make proper use of their position in the company. They should not misuse their position to procure a benefit to themselves or others to the detriment of the company. Fourth, the directors of a company have to make proper use of the information gathered by them, during their tenure as directors. Such information should not be employed for their benefit, that of others, or to the detriment of the company. This has been provided under Section 183 of the Act[Aus1]. Moreover, longstanding legal authority, in the common law nations, has determined that shareholder interests are the same as the interests of the corporation. This was exemplified in Parke v Daily News. In this case the Chancery Court precluded a company from utilising the proceeds of sales of assets to defray ex gratia payment to its erstwhile employees. The duty of a director to maximise the wealth of shareholders was deemed to have been infringed by this use of the asset sale. As such, the corporate governance framework, in its entirety, obliges directors to act in the interests of shareholders. This framework consists of shareholder rights to remove directors, takeover law to provide market discipline on management and directors, facilitate the transfer of shares, use of stock options to provide incentive to directors and management[War08]. 5.0 Duty of good faith The Corporations Act 2001 incorporates several equitable and common law duties. Thus, Section 181 of this Act, requires the officers of a company to act in good faith, in the best interests of the company, and for a proper purpose. In addition, a director who exercises business judgment is deemed to have satisfied the requirements under the duty of care and diligence. The business decision of a director, made in good faith and for a valid reason, in the absence of any material interest in the subject matter, cannot render the director liable[Bar143]. 5.1 Discharging duties in best interests of the corporation The directors and officers of a company are required under the provisions of the Corporations Act 2001, at Section 181(1) to discharge their duties and exercise their powers in good faith and in their company’s best interests. At this juncture, the question arises as to what constitutes the interests of the company, and whether such interests extend beyond the shareholders’ interests. There are several people who oppose the inclusion of stakeholder provisions in corporate law[Mar124]. Their contention is that adequate authority has been provided to directors, and that it is sufficient for safeguarding the shareholders’ interests. 5.2 Conflict Situations It is usually, a simple matter to identify the interest of the directory of his duty, with regard to a third party that conflicts with his duty towards the company[Par67]. In Percival v Wright, it has been declared that the duty of good faith of a director is not owed to a shareholder of the company. Consequently, there is no conflict of interest when a director forms a contract with a shareholder of the company[And081]. As such, the duty of a director to act for proper purposes could be breached, despite the honest intention of the concerned director. This unwelcome situation was noticed in Australian Growth Resources Corporation Pty Ltd v Van Reseema. When this duty is made a part of the duty to act honestly, then there is a contortion of honesty[Lee061]. 6.0 Duty to disclose a material personal interest It is indispensable for the directors of a corporation, under Section 191 of the Act, to reveal their interest in a proposed transaction. In addition, such proposed transaction has to be ratified by the company board in a general meeting. Moreover, a director is prohibited from taking personal advantage of an opportunity that is available to the company, as it is an opportunity for the company and not that of the director. Furthermore, fiduciary duties are imposed upon the directors of a company to circumvent undisclosed conflicts between the interests of the company and their personal interests. Some examples of these conflicts, include; first, a director with a personal interest in a transaction with his company. Second, personal profits that have not been revealed. Third, exploiting confidential information for personal gain[Lat12] 6.1 Duty not to gain an advantage or cause detriment Under Section 182 of the Corporations Act 2001, it is essential for the director of a corporation to abstain from making improper use of his position to obtain an advantage for himself, some other person, or to cause detriment to the corporation. Section 182 of the Corporations Act 2001 is infringed, whenever a director acts with the intention of procuring an advantage or causing a detriment, irrespective of whether this really transpires[Int06]. This was the ruling in R v Byrnes. Moreover, Section 182 of the Act is breached, when the director acts, even after possessing information that the corporation’s financial position is unstable[Pri11]. 6.2 Duty not to make improper use of information Under Section 183 of the Corporations Act, 2001, a director is precluded from making improper use of information to gain an advantage for himself, some other person or causing a loss to the corporation[CCH111]. A director will be deemed to be in violation of the provisions of section 183 of this Act, if his behaviour is with the intention of obtaining an advantage to himself, any other person, or if his behaviour causes a detriment to the company, irrespective of what actually transpires[Pri11]. 7.0 Analysis – Duty to Prevent Insolvent Trading One of the cardinal obligations imposed on the director of a company is to prevent insolvent trading by the company. This duty has been provided under Section 588G of the Corporations Act 2001. The breach of this duty renders a director liable to several sanctions, including criminal conviction and personal liability for the debts of the company. Recovery regarding such personal liability can be recovered by the ASIC, a creditor, or the liquidator of the company[Coo091]. As such, Section 588G of the Corporations Act 2001, renders directors liable, when they do not prevent their company from incurring debts when it can be reasonably surmised that the solvency of the company is in doubt[Tom13]. In such instances, the company would have breached its contractual obligation to repay a debt. The objective of the law, in such cases, is to protect the creditors, when the company is on the brink of financial disaster. The provisions of Section 588H of the Corporations Act 2001, make it evident that the liability of directors is not extinguished, even if they had not been personally involved in the creation of debt. The exception allowed is when directors have a suitable excuse. Some of these excuses are absence from management on account of illness; the adoption of all reasonable measures to prevent the incurring of debt; or reasonable reliance on the information provided by a reliable and competent individual, which had projected the company as solvent[Her121]. The objective behind imposing liability for insolvent trading is to ensure the active participation of all the directors of a company, in its financial monitoring and decision-making. This cannot be circumvented by stating that the director was not integral to the operational structure of the company. Strictly speaking, this merely reinforces the norms of conduct stipulated under Section 180 of the Corporations Act 2001. Significantly, the insolvent trading provisions provide for civil action for compensation by the liquidator of the company; or criminal prosecution, where the director’s conduct is dishonest[Her121]. 7.1 Regulation of directors’ duties The Corporation Law 2001, governs the regulation of the duties of directors. This statute is administered and enforced by the Australian Securities and Investments Commission (ASIC). In the year 1993, the regime of sanctions pertaining to the duties of directors was subjected to vast change. As a consequence, there was a drastic reduction in the criminal law oversight of these duties. The emphasis was upon civil penalties. Prior to these changes, contraventions of the statutory duties of a directors attracted criminal sanctions. This has changed, and criminal sanctions are reserved for the most serious contravention [Gil99]. As such, most of the contraventions invite civil penalties. 7.2 Common law Developments With the decision in Walker v Wimborne, it has been recognised that directors are under a duty to safeguard the interests of creditors, when the insolvency of the company is imminent[Kea07]. This duty has been acknowledged throughout the nations that follow the common law. The conceptual limits to this novel doctrine have not been clearly defined. The traditional duties of directors can be viewed from the perspective of the duty to promote the interests of the protected group or from the perspective of averting harm to the interests of the protected group[Dav06]. From the conceptual point of view these duties could be extended to creditors. While exercising their discretionary powers, the directors of a company have to accord priority to the promotion of creditors’ interests, either with the interests of the shareholders or in isolation. The former would enable directors to utilise their discretion to promote shareholder interests, exclusively. However, they would have to ensure that the interests of the creditors were not harmed[Dav06]. 8.0 Conclusion The aim of this research is to provide the readers with a detailed analysis regarding the extent of burden of the duties to be borne by the directors and their liability for breach of these obligations. This research work examines whether the duties and obligations of the directors are unduly rendered burdensome by the statute and case law. In this regard, this work analyses the statutory duties of directors and the consequences of their breaches. This essay also includes the common law obligations pertaining to directors. As such, the directors’ obligations relating to duty of care and diligence, decision taking for proper purposes, conflict of interests, disclosure of personal interest, and abstaining from trading when the company is insolvent had been taken up for discussion. Relating to these issues, the decided cases were examined. This research, with regard to the topic in question, supported by cases, reveals the extant burden of obligations imposed by the statute and courts on the directors of a company. Insolvent trading provisions impose civil or criminal penalties upon directors, depending on the circumstances of the specific case. A novel concept of derivative action enables shareholders to bring an action against the director on behalf of the company under certain circumstances. Thus, a scrutiny of the case law and statutory provisions, leads to conclusion that the directors of a company are placed in a burdensome situation. 9.0 End References and Table of Cases REFERENCES Psa08: , (Psaros, 2008, pp. 102-103), Bar133: , (Barnes, 2013, p. 3), Bla06: , (Black, 2006, p. 253), Yel08: , (Yeldham Price O'Brien Lusk, 2008), Hay14: , (Hayne, 2014, p. 804), Cas061: , (Cassidy, 2006, p. 258), Bar133: , (Barnes, 2013, p. 4), Pea13: , (Pearce Webster, 2013), Wan15: , (Wan, 2015, p. 72), Tom02: , (Tomasic, Bottomley, & McQueen, 2002, p. 379), Tom02: , (Tomasic, Bottomley, & McQueen, 2002, p. 380), Aus1: , (Australian Institute of Company Directors, 2015), War08: , (Waring, 2008, p. 154), Bar143: , (Barber, 2014, p. 31), Mar124: , (Marshall & Ramsay, 2012, p. 296), Par67: , (Parsons, 1967, p. 397), And081: , (Anderson, 2008, p. 197), Lee061: , (Lee, 2006, p. 8), Lat12: , (Latimer, 2012, p. 695), Int06: , (International Monetary Fund, 2006, p. 41), Pri11: , (Pricewaterhouse Coopers, 2011), CCH111: , (CCH Australia, 2011, p. 222), Coo091: , (Cook, 2009), Tom13: , (Tomasic, Insolvency Law in East Asia, 2013, p. 504), Her121: , (Herzberg & Anderson, 2012, p. 193), Gil99: , (Gilligan, Bird, & Ramsay, 1999), Kea07: , (Keay, 2007, p. 285), Dav06: , (Davies, 2006, p. 327), Dav06: , (Davies, 2006, p. 328), TABLE OF CASES Name vs Name (Year) Volume No. Abbreviated name of report Beginning page of reference ASIC v Adler (2002) 41 ACSR 72 ASIC v Healey & Ors (2011) FCA 717 ASIC v Macdonald (No 11) (2009) NSWSC 287 Australian Growth Resources Corporation Pty Ltd v Van Reseema (1988) 13 ACLR 261 James Hardie Industries NV v ASIC (2010) NSWSC 332 Metal Manufacturers Ltd v Lewis (1988) 6 ACLC 725 Parke v Daily News (1962) Ch 927 Percival v Wright (1902) 2 Ch 421 R v Byrnes (1995) 130 ALR 529 Re City Equitable Fire Insurance Co Ltd (1925) Ch 407 Walker v Wimborne (1976) 137 CLR 1 Read More