Those who are asked to serve as senior officers of Australian companies need to be aware of how companies are managed in the Australian legal context. This is particularly important given recent Australian decisions which have highlighted the consequences of breaching the duties that directors owe to their companies. Corporate Partner Mark Poczman and Corporate Lawyer Vasyl Nair summarise the role of Australian directors and the duties imposed upon them.

The role of the director

All Australian companies must have directors. Private companies (in Australia called proprietary limited companies and identified by use of the abbreviation “Pty. Ltd.”) need only have one director (who can also be the company secretary and sole shareholder of the company). Public companies (in Australia designated as “Limited” companies) must have at least three directors. In every case, a private company must have at least one director who ordinarily resides in Australia while a public company must have two directors who ordinarily reside in Australia.

The director’s role can broadly be divided into two: a decision making function and that of taking action as agent for the company.

The power to make decisions for an Australian company is divided between the company in general meeting of members and the board of directors. The Corporations Act 2001 (Cth) (Act) requires that certain matters must be decided in general meeting. For example, a public company must obtain the approval of shareholders in order to give a related party of that company a financial benefit. For companies listed on the Australian Securities Exchange (ASX), the Listing Rules of the ASX (Listing Rules) also require certain transactions to be approved by shareholders in general meeting.

Absent an applicable statutory or Listing Rule requirement, the division of decision making power between the board of directors and the general meeting will be governed by the company’s internal management rules. These rules are found in the replaceable rules that apply to a company or the company’s constitution. Replaceable rules are provisions of the Act that govern the internal management of a company unless they are displaced by the company (although some replaceable rules are mandatory for public companies).

The Act includes a replaceable rule that states that directors may exercise all of the powers of a company except any powers that the Act or the company’s constitution require to be exercised in general meeting. In the case of private companies with a sole director/shareholder, a statutory provision of similar effect applies.

A company’s constitution is an internal management document adopted by a company which amongst other things has contractual effect as between the company and each director and each company secretary. With some exceptions (for example, companies listed on the ASX), Australian companies do not need to adopt a constitution but it is common for them to do so. Private companies do not need to publicly disclose their constitution, even if they have adopted one.

An individual director may by the exercise of ostensible authority (being the apparent authority of the director as it appears to others) bind a company even though the action may be outside of that individual director’s actual authority given by the constitution or replaceable rules, although to act in this way may expose a director to personal risk.

Directors of companies can either be executive or non-executive directors. Broadly speaking, executive directors are actively involved in the running of a company’s operations while nonexecutive directors are not. Larger companies are more likely to have a mix of executive and non-executive directors. The Corporate Governance Principles and Recommendations of the ASX contain corporate governance guidelines for companies listed on the ASX, including dealing with the mix of independent and executive directors.

Directors as fiduciaries

Directors have a fiduciary relationship with their company and it is this relationship that underpins all of the duties that directors owe to a company. Broadly, a fiduciary relationship is characterised by a person (the director) being appointed to act for the benefit of another person (the company) in circumstances where the appointment gives the appointed person powers which could be exercised to the detriment of the other person.

In order to prevent directors (in their capacity as fiduciaries) acting to the detriment of a company, they have imposed on them general law obligations of disinterested conduct in the form of duties and statutory duties imposed by the Act.

General law duties

The general law duties owed by a director to a company include:

  • the duty to exercise care and diligence in the exercise of the powers which form part of their office
  • the duty to act in good faith in the interests of the company as a whole
  • the duty to use their power for proper corporate purposes
  • the duty to avoid situations in which they have (or may have) a personal interest that conflicts (or may conflict) with the interests of the company, and
  • the duty to give adequate consideration to matters for decision and to keep decisions unfettered.

Statutory duties

The statutory duties of directors that supplement the general law duties described above include:

  • the duty to exercise their power and discharge their duties with reasonable care and diligence (broadly the same as the standard imposed on directors under general law)
  • the duty to exercise their power and discharge their duty in good faith in the best interests of their company
  • the duty to exercise their power and discharge their duty for a proper purpose
  • the duty not to gain an advantage for themselves or someone else or cause detriment to the company by improper use of their position or by improper use of information gained from their position, and
  • the duty to disclose any material personal interest they may have in a matter that relates to the affairs of a company.

Insolvent trading

A director also has a statutory duty to prevent a company from incurring a debt while a company is insolvent or if it would become insolvent by incurring that debt, while that director had reasonable grounds for suspecting that the company was insolvent or would become insolvent as a result of incurring that debt. As defined by the Act, a company is insolvent if it cannot pay all of its debts as and when they become due and payable. As presently formulated, this statutory duty may prevent directors from restructuring a poorly performing company outside of formal external administration (which can be costly and complex).

In order to overcome this issue, the Australian government has recently (19 January 2010) released a consultation paper which looks at a series of options for reform to give some protection to directors seeking to help their ailing companies. Amongst the options being considered are a modified “business judgment rule” enabling directors to balance creditors’ and members’ interests. The period for submissions ends in March 2010 and we would expect draft legislation to follow sometime after that.

Who owes these duties?

A person may owe general law duties and statutory duties to their company even if they do not hold the office of director. General law duties are owed by senior executive officers as well. Similarly, in a statutory context, some of the duties owed by directors are also owed by ‘officers’. An officer is defined by the Act to include any person who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the company, and any person who has the capacity to affect significantly a company’s financial standing.

In the recent Jamies Hardie case, the general counsel and chief financial officer of a company were each held to be officers of the company on the basis that each participated in decisions that affected the whole or a substantial part of the business of their company, resulting in significant personal exposure for those persons. Click here for recent articles by this firm on that important case.

Even those duties expressed to be owed only by directors (for example, the duty to prevent insolvent trading, mentioned above), may also be owed by persons not formally appointed as directors. The statutory definition of ‘director’ includes shadow directors (that is, persons not validly appointed as directors but in accordance with whose instructions or wishes a board is accustomed to act). It also includes alternate directors and those acting de facto as a director.

Breach of duties and removal of directors

A director who breaches a general law or statutory duty owed to a company may face court action by the company (or in certain circumstances, by the shareholders) to claim various remedies which could include injunctions, damages and an account of profits. That director may also face action by the corporate regulator, the Australian Securities and Investments Commission (ASIC). ASIC can itself apply to court for various orders including disqualification orders and pecuniary penalties. In the James Hardie case, at ASIC’s application, disqualification orders were imposed for periods ranging from 5 to fifteen years and pecuniary penalties imposed for amounts up to $350,000. Criminal charges can also be brought against directors who breach certain statutory duties.

The director breaching his duty may also be removed from office and have his or her service arrangements terminated. The Act contains a replaceable rule enabling members of the company to punish a director by removal from office (unless in the case of private companies that rule has been displaced by the company’s constitution; for public companies the rule is mandatory).

Other duties

As the principal decision making and executive organ of a company, directors and senior officers also owe specific duties in a wide variety of legal contexts, including environmental, occupational health and safety, taxation and trade practices matters. Piper Alderman regularly advises directors on their responsibilities in a variety of contexts and has partners well qualified to assist with queries in relation to this important and complex area of corporate law.