The Duty of Directors of Companies - Research Paper Example

Name) (Instructors’ name) (Course) (Date) ‘The Duty of Directors of Companies’. In the last ten years or so in Australia, there has been an estimated loss of about seven hundred million dollars of money belonging to investors. The money has been lost in public companies that were unsuccessful. On both a personal as well as national level, the consequences of losses of these proportions have as a matter of fact been very serious. In several of those cases where there have been formal investigations, the inspectors concerned have attributed the failure of the company to incompetence in carrying out managerial tasks. In very few of the cases investigated have fraud been established and found to be the most significant factor.1 In additions, the failures mentioned have occurred in an economic climate that has generally been regarded as expansionary and prosperous. The fact that the system in Australia took a back seat and allowed the situation to arise has been the topic of public concern that is widespread as well as prevalent criticism. In light of the outlined circumstances, one might have thought that, as an initial step towards redressing the state of affairs, extensive litigation of a civil nature against the company directors concerned might have proceeded.2 It is a baffling fact that his has not been the case. It is partly the submission that the explanation of this fact was probably brought about by the present law that relates to the liability of directors for acts that are negligent has some shortcomings. The paper seeks to examine the law, particularly on whether a company can and whether it should recognize a cause of action against the board for failing in its duty to guard the welfare of the company. The examination of the elements of the law as well as the implication of the recognition of the law as concern the same will also be pertinent. One of the earliest and certainly presently one of the most authoritative decisions and formulations of liability for negligence for a director of a company occurred in the infamous judgment delivered by Romer J. In the case of, Re City Equitable Fire Insurance Co Ltd. The judge was of the opinion that ‘a director of a company need not showcase or exhibit in his performance of his duties a degree of skill that is greater than that which may plausibly be expected of someone of his experience and knowledge’.3 Presently, a general statutory provision that deals with the duties of a director is in place in Australia. The provision was commenced in Australia for the initial time under the provisions of the Australian Uniform Companies Acts.4 Section 124(1) of the Act provides that ‘A director shall at all time operate in an honest manner and shall use diligence that is reasonable while discharging the duties of his office’. The duty is expressed and laid out in the Act to be in addition to any existing rule of law that related to the duties of directors.5 The section makes provision for both criminal and civil sanctions when there is breach of that duty.6 When the sections was initially enacted, the view was expressed that it seemed to lay down one single, objective standard of care which was not in any manner related to a particular director’s capacity personally as contemplated,7 for instance, in the formulation and elaboration of his duty of care in Re City Equitable Fire Insurance Co. Ltd.8 Non-executive directors. A non-executive director is not permitted anymore to take a back sit and conduct his activities to lower standard than that of an executive director. Nonetheless, a non-executive director is not ordinarily expected to participate in the day to day management of a company. Daniels v Anderson (1995) 37 NSWLR 438 colloquially known as the AWA Case highlighted the practical consequences of the duties that apply to non-executive directors. Facts of the case. AWA was an Australian company that was long established whose business included the exportation and importation of electronic equipments. The company made the decision to hedge against fluctuations of currency by engaging in the forward purchase of foreign currency against agreements and contracts of goods that were imported. Koval was the employee who was charged with managing operations of foreign exchange. The dealings of Koval subjected the company to losses that approached fifty million United States dollars (50 Million USD). Koval was able to conceal the facts of these losses. At the time of Koval’s employments, the auditors of the company Delloite Haskins & Sells carried out two audits. In both occasions of the audit, the activities of Koval were never disclosed fully to the AWA Board despite the fact that the auditor has taken note of the defects on the internal control systems of the company. The failure by AWA to establish internal controls that were adequate as well as to record and keep accounts had permitted and facilitated the concealment of the losses. AWA sued the auditor for negligence for failure of drawing attention to the deficiencies and to qualify the reports of the audit. The auditor denied any breach of duty owed to AWA and made a cross-claim against the same and, inter-alia, the non-executive directors for liability in contributory negligence. The claim against the non-executive directors is the issue at hand as it is what is of immediate interest in this case. Rogers J, the trial judge made an examination of the interaction of directors and their general law duties as well as the judicial statements that were made in the insolvent trading cases.9 The judge recognized that what is expected of a director of any particular company is the highly dependent on several things; The actual experience and knowledge of the particular director, The nature and extent of the company’s business as well as, The distribution of tasks and responsibilities in the particular company.10 Other than specific guidelines set out under statute or by the Articles of Association of a company, the judge stated that the duties of non-executive directors as a board member for a public company include; the setting of goals for the company, the appointing of a chief executive for the company, overseeing the managers’ plans for the organization and acquisition of human resource and financial resources geared towards the attainment of the goals of the company as well as reviewing at intervals that are reasonable the progress of the company towards the attainment of the goals.11 The judge went on to state that non-executive directors were expected: To take steps that were reasonable to place themselves in the positive to monitor and guide the company’s management; To obtain an understanding that is general of the company’s business and the effect that an economy that is changing might have on that business; To bring a judgment that is informed and independent to bear on the various matters that find their way to the board for decisions.12 Justice Roger careful considered the application of principles of proximity of the High Court which stipulate that non-executive directors owed.13 On Appeal, the majority of the New South Wales Court of Appeal was of the opinion that non-executive directors had and owed a common law duty in their performance of their office to take reasonable care. From the foregoing, thus as a general rule, a director should acquire at the very least an understanding that is rudimentary of the company’s business. In addition, a director ought to be well-vast with the essentials of the business that the company is doing. The directors of a company are under an obligation that is continuing to be informed about the activities of the corporation. It is worth to note that directorial managements do not entail an inspection that is detailed of everyday activities, but rather they ought to monitor generally the corporate policies and affairs. In as much as the directors are not expected to make an audit of corporate books, they ought to maintain familiarity with the status of the company as far as finances are concerned. In relation to the financial position of a corporation, they ought to review regularly the financial statements. In relation to reviewing of financial statements, it is important to note that this may give rise to a duty to make further inquiries into issues that may be revealed by the statements of finance. Upon the realization of a course of action that is not legal, a director has upon him a duty to object and if the corporation is unwilling to correct the action, he should resign as a matter of prudence.14 The introduction of the statutory business judgment rule in s. 180(2) of the Corporation Act 2001 (Cth). In due regard of the risky nature of many businesses, the courts are not willing to intrude into the affairs of the boardroom and second-guess the decisions of the directors. Provided the directors have conducted their affairs properly by performing their duties without serving their personal interests and they have been keen enough to inform themselves as well as acted in what they truly, the courts will seldom if at all interfere unless the decisions reached are prima facie unreasonable. It only when honest directors make bad decisions will they face an action for negligent acts. Obviously directors cannot make appalling decisions and not be pursued by the long arm of the law. The principle is referred to as the business judgment principle. In some jurisdictions such as in Australia, this principle has been enshrined in. It sort of blunts the proverbial blade of the duty of diligence and care imposed upon the directors of corporations or companies.15 Section 180 of the Corporations Act provides for care and diligence expected of a director and other officers.16 A corporation is expected to exercise their powers as well as discharge their duties with a degree of diligence and care that would be exercised by an individual who is reasonable if they: Were the director of officer in a corporations in the same circumstance; and Occupied that office held by the director of officer and had similar responsibilities allocated to them in the corporation.17 The Business judgment rule. A company or corporation’s director or any other officer who makes a judgment in business is taken to have fulfilled the requirements set out in subsection (1) above. They are also taken to have met the corresponding obligations at common law and in equity in reverence of the judgment made if they;18 Made purpose that is proper;19 Do not have in the subject matter of the judgment a personal material interest,20 Inform themselves well of the issue of the judgment to the degree that they deem reasonably to be suitable and appropriate,21 and Believe rationally that the judgment is in the best interest of the corporation.22 The Act further states that the conviction by the company director or officer that the decision is in the unsurpassed interest of the company is one that is rational unless the belief is one which no person who is reasonable in that similar position would hold.23 The above subsection operates only in relations to duties under that section and duties under common law or in equity that are equivalent. This includes the care duty that arises under common law principles that govern liability for acts that are negligent. In the section, business judgment implies any decision to take or failure to take action in respect of a matter that is relevant to the business undertakings of the company.24 From the foregoing, section 180(1) created a standard of conduct which is normative to which all the directors and officers must adhere and in so doing essentially codifies the general rule under the law. The business judgment rule provided for in section 180(2) is a defence that contravenes section 180(1) of the corresponding care duty under common law or in equitable doctrines. The Explanatory Memorandum to the Bill that sort to introduce section 180(2) highlights the that that section is a ‘safe harbor’ provisions which is intended to offer protections to the directors and officers who might take advantage of the opportunities which involve responsible risk-taking.25 Can or should company law recognize a cause of action against board for failing in its duty to protect company’s interest?” Corporate Governance is the responsibility of the board of directors of a company, a corporation or a firm. The management of a company runs the company as well as supervises the daily activities and operations. It is however, the duty of the board to govern the company by overseeing the overall management and to embody the interest of the company’s owners or shareholders.26 Under the law, a company regardless of the size is obligated to consist of a board of directors that is elected by the shareholders. The directors thus are charged with certain duties and responsibilities. They have a fiduciary duty to the shareholders. Thus, the directors as well as other corporate officers can be held accountable for failing to meet those fiduciary duties to the stockholders.27 The investors of a company as well as the general public particularly those persons who are interested in the financial reports that are released by companies that are traded publicly are entitled to reports that are fair and accurate and this boards of directors of such companies have a legal obligations to make sure that the reports are as accurate as possible. Recent auditor malfeasance, failure in business and key material inadequacies in disclosure of financials however has caused a serious erosion of confidence by the public in the financial reporting of such companies. 28 For instance, in the USA, as a result of lack of public trust, Congress deliberated and enacted in 2002 the Sarbanes-Oxley Act. Common law had traditionally held that directors of companies have a fiduciary duty that is primary to the corporation and a corresponding secondary duty when it came to the shareholders. The Act has essentially made directors of companies principally accountable to the shareholders of the company. To state the Act simply, directors are basically required to avoid any employee, financial, family or business relations with the companies on whose board they seek to serve. The Act generally emphasizes clearly the avoidance and averting of conflict of interest and stresses on independence. It is necessary to accord protection to the authority of directors in the exercise of their duties so as not to insulate the directors from responsibility or liability. When there lacks an express statutory acknowledgment of a business judgment rule, losses and costs will be incurred inevitably due to the failure by the directors and the company to take advantage of certain opportunities that involve risk-taking that is responsible. The directors of companies ought to be the subject of high level of accountability, a failure to acknowledge expressly that directors should not be liable for decisions that can have the effect of encouraging behavior in business practice which is averse to risks.29 Directors and other corporate officers, notwithstanding the limited liability of a corporation, carry the risk of personal liability for loss suffered by the company of by the shareholders as well as for any loss suffered by third parties in certain circumstances. The law should thus set out the duties that directors and officers owe to the company and the shareholders. The elements that relate to liability to the company are as follows; A duty to exercise due diligence and care’ A duty to act for the proper purpose and in good faith, A duty to avoid situations of circumstances of conflict of interest. The duties have been imposed by the common law, equity as well as statute law. In Australia, the duty to exercise due diligence and care is a necessity under the common law and equitable doctrines and is enshrined under section 180(1) of the Corporations Act. There is an objective judgment of standard of care and diligence and the same is measured by reference to the ordinary prudent person depending on the business and size of the company, its surrounding circumstances as well as the extent of the officers or directors who are responsible within the company. The duty is however subject to the rule on business judgment by which directors and other officers are permitted to make judgments in business in the spirit of the enterprise in question. Any breach of the duty enshrined in the Act may lead to an action for indemnity by the company at common law or for compensation in equity or for what is referred to as a ‘compensation order’ under the Corporations Act in section 1317H. The ASIC which is acronym for the Australian Securities and Investment Commission is also permitted by law to institute proceedings for a pecuniary penalty of up to two hundred thousand USD under the Corporations Act in section 1317G. In addition, the duty that is owed to the company by officers and directors to operate in due regard and good faith and for a purpose that is proper arises under the Corporations Act.30 Reforms: The liabilities of directors and officers. The law that related to liabilities of officers and directors has progressively become a minefield with over seven hundred laws both state and federal in areas that range from place of work safety regulations to environmental controls.31 The sheer number and complexity of these laws has led to an outcry by many company directors who admit to an increasing reluctance to take up board positions with some of them even considering stepping down from their roles principally in the wake of the ruling by the Federal Courts against the directors of the Centro group of companies.32 A concern that has arisen due to imposing a derivative liability on directors and officers of corporations are having a negative impact on the countries entrepreneurialism and growth economically due to the fact that directors are being compelled to adopt a very cautious approach. As a result, they are being curtailed from competiveness, responsible risk, innovations and in the end profitability.33 Directors' Liability Reform Project The (COAG) acronym for Council of Australian Governments established as part of the 27 deregulation priorities identified by COAG the Director's Liability Reform Project in 2009.34 The Project for Reform forms part of the wider National Partnership Agreement of COAG's to convey a Seamless National Economy.35 The above seeks to bring to harmony the approach to impose personal liability of a criminal nature for corporate errors and faults by requiring jurisdiction to make an audit of their laws against the agreed principles of the COAG as well as to amend the provisions of the legislature to reflects an approach that is truly national which imposed criminal liability of a personal nature on corporate officers. 36 Conclusion. In Australia, courts have held in the past that there is no significant difference between the common law duty of care and the statutory duty in terms of the standards to be applied. this implies that a directors who had breached the statutory duty if care will also as a fact have breached the duty of care that is under the regulations and principles on negligence as well as the duty of care which arises under the doctrines of equity. The law should provide for a cause of action when directors breach their duty of care however subject to the business judgment rule. . Work cited. Statutes. Corporations Act of 2001. Uniforms Companies Act. Cases. In Re Equitable Fire Insurance Co. Ltd. (1925) Ch 407. Daniels v Anderson (1995) 37 NSWLR 438. ASIC v Healey & Ors [2011] FCA 717. Books. Hicks, Andrew and Goo, S. H. Cases and materials on company law (New York: Oxford University Press, 6th Ed.2008) Mugambwa, J.T. Amankwah, H.A. and Haynes, C.E.P. Commercial and business organisations law in Papua New Guinea ( New York: Routledge, 2007) Journals Byron, Ellen. "Corporate Governance (A Special Report): Managers: Keep Out: Independent Directors Have a Lot More Power These Days, and a Lot More Responsibility." (2004) Wall Street Journal. DeMott D, ‘Directors’ duty of care and the business judgment rule: American precedents and Australian choices’ (1992) 4 Bond Law Review 133, 140. Fleming, John M. "Audit Committee: Roles, Responsibilities, and Performance." (Summer 2002) 73 Pennsylvania CPA Journal 29–32. Ramsay, Ian. Directors' Duties in Australia: Recent Developments and Enforcement Issues: University of Melbourne - Melbourne Law School. (1999) 3 Company Financial and Insolvency Law Review 2. Trebilcock, M. J. ‘The liability of company directors for negligence’ (1969) 32 The Modern Law Review 5 499–515. Electronic journals. Flint, Geoffrey "Non-Executive Directors’ General Law Duty of Care and Delegation of Duty: But do we need a Common Law Duty of Care?" (1997) 9 Bond Law Review 2, 5. Hooper, Matthew "The Business Judgment Rule: ASIC v Rich and the reasonable-rational divide" (2011) < http://epublications.bond.edu.au/cgej/22> Sernia, Antoinette & Barkoczy, Mei-Ling, “Directors Beware: Corporate Sanctions and Defences, a Matter for Review?” (2009) 16 eLaw Journal: Murdoch University Electronic Journal of Law 1, Other sources. Michelle Welsh, ‘The Use of Civil Sanctions for Breaches of Corporate Law’ (Working Paper No 7, Corporate Law and Accountability Research Group, Faculty of Business and Economics, Monash University, 2007) 6. Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998 (Cth) at 17 [6.3]. Taskforce on Reducing Regulatory Burdens on Business, Taskforce on Reducing Regulatory Burdens on Business (Belconnen: Productivity Commission, Regulation Taskforce, 2006) 90. 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