Directors are subject to strict duties at law. This is because the power conferred upon directors - to control the management of a company - has the potential to create two issues. First, directors may be tempted to misuse their position for their own benefit. Second, shareholders may be vulnerable, particularly shareholders who are passive investors and do not follow the company’s management on a day-to-day basis. The law has responded to these issues by creating directors’ duties.
Directors owe duties under the general law and statute. The classification of the duty can be important because different remedies are available depending upon the genesis of the duty.
In equity, the relationship between director and company is a fiduciary relationship, and a high standard of loyalty is set. The standard of loyalty is reflected in a number of positive duties, as well as in some instances, negative ones. The positive duties of loyalty include the duties to act in good faith and in the best interests of the company, to act for proper corporate purposes, to give adequate consideration to matters for decision, and to keep discretions unfettered. These duties are reinforced by section 181 of the Corporations Act 2001 (Cth). The negative aspects of the duty of loyalty are those that require directors to avoid conflicts of interest of various kinds. These duties are reinforced by sections 182 and 183 of the Corporations Act 2001 (Cth).
Under the common law, directors owe a duty of care to their company. This is reinforced by section 180(1) of the Corporations Act 2001 (Cth).
Business Judgment Rule
In deciding whether a director has breached any of their duties, courts are reluctant to substitute their own judgment for the business judgments made by directors. There is a statutory “business judgment rule” that applies in respect of the statutory duty of care and diligence. By its terms, the statutory business judgment rule only applies to the duty of care and diligence (section 180(1)) and not to the duties imposed by sections 181 or 182 or their equivalents at general law.
The statutory business judgment rule provides that a director, or other officer of a corporation, who makes a business judgment is taken to have met the requirements of section 180(1), and their equivalent duties at common law and in equity, in respect of the judgment, if they:
- make the judgment in good faith for a proper purpose;
- do not have a material personal interest in the subject matter of the judgment;
- inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
- rationally believe that the judgment is in the best interests of the corporation.
Notwithstanding the apparent limited statutory reach of the business judgment rule, there is a form of business judgment rule that has been developed by the courts that applies to the wider general law duties and statutory duties of directors and officers.
If a director has breached one of their duties, they may be exonerated if they acted honestly and in all of the circumstances ought fairly to be excused: sections 1317S and 1318 of the Corporations Act 2001 (Cth). In order to rely on these sections, the director would need to prove that they acted without deceit or conscious impropriety, without intent to gain an improper benefit, and without carelessness or imprudence.
Directors are subject to strict duties at law but this is necessary to protect shareholders from the inherent risks that are present when a person entrusts their property or affairs to another. If, however, directors make business judgments in good faith and for proper purposes, and act honestly, the court will be reluctant to intervene.