Directors Duty of Care and Diligence - Assignment Example

Corporation Directors Name Course Lecture Date Question one 1 (b) Directors duty of care and Diligence Section 180 of the Corporation Act 2001 (cth) obligates directors of companies to act with care and diligence while making business decisions on behalf of the company1. The standard of care and diligence is that of a reasonable person who is in the position of director, and where the corporation’s circumstances are similar2. If a reasonable person with the same responsibility and office would have taken a similar course of action then it is taken the director did not act in breach of his duty of care and diligence3. However, Apollo and Rocky as the executive directors of DEF Ltd failed to exercise their duty of care and diligence. They insisted on continuation of exploration activities although they knew gold deposits did not exist in commercial quantities in the sites the company was exploring. A reasonable person in similar circumstances would have discontinued the exploration activities in order to protect the shareholders’ capital. Although it is generally agreed that risk-taking is an essential aspect of business success, reckless risk taking is generally frowned at. According to Tomasic, Bottomley and McQueen, the success of a business venture is closely related to the ability of its managers to evaluate risks and deciding which course of action to take depending on the promise of success of each course of action4. However, Apollo and Rocky decided to go ahead with the exploration despite knowing that little chance of success. This is a clear breach of the duty to act with care and diligence imposed by section 180 of the Corporation Act. 1(b) The business judgement rule defence Apollo and Rocky may rely on the business judgment rule as a defence of acquisition of violating their duty of care and diligence5. As set out in section 180 (1) of the Corporation Act 2001 (cth), the business judgment rule means that directors can escape acquisition of breach of the duty of care and diligence if their business decision are honest, well informed and rational6. However, the business judgment rule is not meant to insulate directors from liability. Instead, it seeks to produce a business environment where directors are not afraid to take risky business decisions. Therefore, a director seeking to rely on the business judgment rule must fulfil the conditions set in section 180 (2) of the Act7: Decision must be in good faith and for the proper purpose; Must not have material interest in the subject matter of the decision; Must be reasonably informed about the subject matter to the point of believing it is appropriate; Must rationally believe that the business judgment is in the best interest of the company. However, the business decision made by Apollo and Rocky does not fulfil the second and last conditions of section 180 (2)8. The information available strongly suggested that the decision to continue with mineral exploration was not appropriate. Furthermore, continuing with exploration was not in the best interest of the corporation as it would risk loss of shareholder capital. The company had already lost $5 million; a quarter of the $20 million it had raised from investors. 1(c) The CEO responsibility to shareholders According to Tomasic, Bottomley, and McQueen, the chair of the board is responsible for providing leadership and guidance to the board9. He is also responsible for ensuring that the corporation’s duties to its shareholders are not being overlooked. In this case Clubber as the chair of the board is responsible for ensuring the business decisions of the board are made with care and diligence as required by Section 180 of the Corporation Act 2001(cth)10. The chair of the board is a powerful position that can exercise control over the decisions made by the directors11. Under the Corporation Act section 181, Clubber is also responsible to shareholders’ to ensure that all the boards’ decisions are in the best interest of the corporation and its shareholders. Clubber did not block the decision to continue drilling for gold despite knowing that the gold deposits in the region they were prospecting did not exist in commercial quantities. Clubber was more worried about avoiding a confrontation with Apollo and Rocky. Instead Clubber should have taken steps to ensure that the shareholders’ best interests were served by discontinuing drilling. It can thus be concluded that Clubber’s inaction led to the loss of $15 million in shareholder capital which could have been easily avoided. Therefore clubber is in breach of his duty of care and diligence and his duty to ensure the best interest of the Corporation is served. 1(d) The CFO responsibility to the corporation’s shareholders Drago as the company Chief Financial Officer (CFO) has a fiduciary duty of care and diligence under section 180 of the Corporations Act 2001 (cth)12. This duty requires that the CFO exercise prudence in carrying out his duties as a company officer13. A CFO is responsible for two important role in a corporation decision making; controllership duties and treasury duties14. In the context Drago carries his controllership duty properly by providing accurate and timely information about the profitability of their exploration activities. However, Drago clearly fails in his treasury duties by failing to prevent the corporation from continuing with an unviable exploration investment. According to Tomasic, Bottomley, and McQueen, the assessment of the profitability and viability of a corporation’s financial investments is the CFO’s responsibility. The CFO takes into consideration the risk involved in going through with an investment and recommends to the board on whether to take up the investment or not. Drago would have been the first person to know that the gold deposits in their exploration sites were not available in commercial quantities. Drago should have advised the board to abandon the drilling activities as the investment in the exploration was no longer prudent. However, Drago and Clubber gave in to the eternal optimism of the other directors and agreed to an imprudent business decision. Drago therefore breached his duty of care and diligence by going along with the decision to continue with drilling operations that were destined to fail. Furthermore, the decision did not also serve the best interest of the corporation as required by section 181 of the Corporation Act 2001(cth)15. Question 2(a) Exercise of Director’s powers for improper purpose Section 181(1) of the Corporation Act 2001(cth) obligates directors to exercise the powers given to them by the corporation in the best interest of the corporation and for a proper purpose16. The doctrine of proper purpose means that directors must exercise their power for the purpose that they were conferred17. One of the most commonly abused powers by directors is the power to issue shares. Directors are conferred with the power to issue shares so they can be able to raise capital for the corporation18. The purpose of raising funds is thus recognized by courts as the main purpose of any issue of shares. According to Winthrop Investments Ltd v Winns Ltd (1979) ACLC 32, other proper purposes for issuing shares include promotion of desirable business partnerships, improvement of corporation’s financial position, or the maintainace of the minimum necessary membership of the corporation19. On the other hand Ngurli Ltd v McCann (1953) 90 CLR 425, at 440 indentifies improper purposes as; issue of shares to defeat hostile takeovers, entrench the board controls, or to favour one group in the struggle over ownership of the company. Therefore, the directors of Citrus LTD acts of issuing shares to a director were in breach of the duty of exercise their power in the best interest of the corporation and for a proper purpose. The directors actions were clearly not intended to raise capital for the company or for any of the other proper purposes identified in Investments Ltd v Winns Ltd [1979] ACLC 3220. Instead the director’s purpose was defeating the takeover bid by Anglo Brit Ltd which is one of the improper or collateral purposes identified by Ngurli Ltd v McCann (1953) 90 CLR 425 21. As seen in Hogg v Cramphorn Ltd [1967] Ch 254, allotment of shares with the intention of making it difficult for a hostile takeover to occur is an improper purpose22. According to Buckley J, even if the directors believe that the best interest of the corporation is being served by the issue, the purpose of exercise of power is the most important consideration. Therefore, the power of directors to issue shares is limited to instances where such issues aim to raise capital for the company. Question 2(b) How far does the duty of loyalty to shareholder extend When directors are faced with a hostile takeover they must not violate their duty of loyalty to their existing shareholders23. Section 181(1) of the Corporation Act 2001 (cth) requires that directors exercise their powers in the best interest of the corporation and for proper purpose24. The section thus means that directors only have a duty of loyalty to the corporation and by extension to the shareholders of the organization. According to Jim Corkey, the directors of a corporation are under no obligation to take-up takeover bids even if the offer is premium25. Directors can reject a takeover bid as long as it is good business judgment as provided for by the business judgement rule. In the case, Anglo Brit Ltd are not existing shareholders of Citrus Ltd and therefore the directors do not owe them a duty of loyalty. Anglo Brit cannot argue that the directors are not working in the best interest of the corporation and for a proper purpose if they are not existing shareholders. In this instance only a shareholder of Citrus limited may sue for breach of the duty to exercise power for the best interest and for the proper purpose. In Hogg v Cramphorn Ltd, the directors were found to have made improper use of their powers by allotting shares with weighted voting power with the aim of defeating a takeover attempt by a shareholder; Mr. Hawton26. Similarly, in Ngurli Ltd v McCann, the controlling director was also ruled to have used his power to issues shares improperly by trying to benefit his friends at the expense of the McCanns who were minority shareholders. Finally in Howard Smith Ltd v Ampol Petroleum Ltd (1974) UKPC 3, the court ruled that an improper issue had been made to the detriment of Ampol Petroleum also an existing shareholder27. Clearly, courts have held that improper use of the power to issue shares is only relevant where the complaint is a shareholder within the corporation. In contrast, Anglo Brit were not existing shareholders of Citrus Ltd and therefore the directors of Citrus Ltd owed them no duty of loyalty. Instead the directors of Citrus owed their existing shareholder a duty to act in their best interest and for a proper purpose. It can be argued that the decision to use defensive tactics against the takeover was good business judgment. The directors of Citrus limited honestly believed that they were trying to get the shareholders of Citrus Ltd a better price than the 1.2 dollars per share. Therefore, Anglo Brit has no grounds to sue the director as they do not owe Angle Brit Ltd a duty of loyalty. Bibliography A. Articles/Books/Reports Corkery, Jim F, ‘Directors’ powers and duties’ (Longman Cheshire, 1987). Farrar, John Hynes, ‘Corporate Governance in Australia and New Zealand’ (Oxford University Press, USA, 2001) Tomasic, Roman, Stephen Bottomley, and Rob McQueen, ‘Corporation Law in Australia’ (The Federation Press, 2002) B. Cases Corkery, Jim F, ‘Directors’ powers and duties’ (Longman Cheshire, 1987). Hogg v Cramphorn Ltd [1967] Ch 254 Howard Smith Ltd v Ampol Petroleum Ltd (1974) UKPC 3 Investments Ltd v Winns Ltd [1979] ACLC 32 Ngurli Ltd v McCann (1953) 90 CLR 425 Winthrop Investments Ltd v Winns Ltd [1979] ACLC 32, C. Legislation Corporation Act 2001 (cth), s 181(1) Read More