Each director of an Australian company owes duties to the company. At a basic level, those duties are designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company.
The five directors’ duties
Directors are subject to a number of statutory and general law obligations, including:
- Care and diligence: to exercise their powers and discharge their duties with due care, skill and diligence;
- Good faith and proper purpose: to act in good faith in the best interests of the company, and for a proper purpose;
- Not to misuse information or position: not to improperly use or profit from their position or information obtained as a director to gain an advantage for themselves or someone else, or to cause detriment to the company;
- Avoiding conflicts of interest or duty: to avoid conflicts between the director’s personal interests and the company’s interests, and between the director’s duties to the company and the director’s duties to anyone else; and
- Not to fetter discretions: to give adequate consideration to matters for decision and to keep discretions unfettered.
These duties and their practical implications are considered further below.
There is a significant amount of case law on the scope and content of these duties and their application in different factual scenarios. Given its breadth, that case law is not explored in this reference guide.
Duties of care and diligence
Scope of duties
Section 180(1) of the Corporations Act 2001 (Cth) (Act) requires a director to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if:
- they were a director or officer of a corporation in the company’s circumstances; and
- they occupied the office held by, and had the same responsibilities within the company as, the director or officer.
Similar duties also exist under the common law and in equity.
The concept of a ‘reasonable person’ means that the duty applies an ‘objective’ standard of care (i.e. a standard that an ordinary person might be expected to follow on his or her own behalf). In determining the required standard of care, the court also takes into account the company’s circumstances and the individual director’s responsibilities within the company.
Whilst the scope of the duty depends on the circumstances, it is clear from the case law that all directors are required to satisfy some core, minimum standards of care, skill and diligence, which include to:
- become familiar with the fundamentals of the business and operations of the company;
- keep informed and make appropriate inquiries about the company’s activities;
- generally guide and monitor the company’s activities;
- maintain familiarity with the financial status of the company (and to have the ability to read and understand financial statements and have a basic knowledge of accounting practice and material accounting standards);
- have a reasonably informed opinion of the company’s financial capacity and solvency; and
- carefully review, and apply their own minds to, any financial report and directors’ report the company is required to prepare under the Act (including by considering whether the information in the reports is consistent with their own knowledge or omits any material matters, and making appropriate inquiries if they are uncertain).
A director is also expected to attend board meetings unless exceptional circumstances (such as illness) prevent their attendance. Further, a director must be attentive at board meetings and cannot be excused from liability on the basis that he or she paid no attention to proceedings.
A director is entitled to delegate to others some responsibilities that would otherwise need to be performed by the director. However, the director is still responsible for adequate supervision, and for applying an inquiring mind and their own knowledge to the conduct of, and information provided by, the delegate. Wilfully ignoring the delegate’s performance will not be satisfactory. There are also some responsibilities that cannot be delegated (eg final approval of accounts).
What is meant by the ‘interests of the company’?
A director will breach this duty if they fail to give proper consideration to the separate interests of the company ahead of other interests. This is because the duty is generally owed to the company itself, not to individual shareholders or third parties.
Directors must take into account the interests of the company’s shareholders in order to satisfy the duty to act in the best interests of the company.
Where the only shareholder is its parent company it is, of course, appropriate for the directors to bear in mind the interests of that parent company. Under section 187 of the Act, a director is taken to act in good faith in the best interests of a wholly owned subsidiary if the subsidiary’s constitution authorises the director to act in the best interests of the holding company, the director does so in good faith and the subsidiary is not insolvent.
Further, it is necessary for directors to have regard to the interests of creditors, particularly where the company is insolvent or nearing insolvency.
What are ‘proper purposes’?
The powers of a director must be used for the purpose for which they were given, not a collateral purpose.
An improper purpose would include where the director uses a power to obtain advantage for themselves or someone else.
This is not an assessment of whether a business decision was a good or a bad decision. Rather, it is an assessment of how and why a particular power was used, and whether this is consistent with the purpose for which the power was given. For example, where directors issue new shares, was the share issue intended to raise money for the company or were the shares issued for a collateral purpose such as delivering control of the company to a particular person, ensuring that the directors remain on the board or obtaining some financial benefit for a director?
Duties of good faith and proper purpose
Scope of duties
Section 181(1) of the Act requires a director to exercise their powers and discharge their duties:
- in good faith in the best interests of the company; and
- for a proper purpose.
This means that the duty to act in good faith is actually two separate duties. Two corresponding duties also exist at general law.
Statutory duties not to misuse information or position Scope of statutory duties Sections 182 and 183 of the Act require that a director must not improperly use their position, or improperly use information obtained because they are or have been a director, officer or employee of the company, to:
- gain an advantage (directly or indirectly) for themselves or someone else; or
- cause detriment to the company.
The statutory duties not to misuse information or position in practice mean that:
- a director may not apply the company’s property either for the director’s personal benefit or for the benefit of any other person without the company’s authority (commonly requiring shareholder approval or constitutional authorisation); and
- a director must not make unauthorised use of confidential information belonging to the company.
Being a director may bring various profitable business opportunities one’s attention. Although directors may wish to take advantage of these opportunities, they must exercise care and might ultimately not be able to do so legally. Because of the obvious possibility of directors being attracted to business opportunities and the conflicts which may arise, the law curtails the freedom of directors to exploit those opportunities.
To ensure that directors comply with these requirements, the simple rule is to regard all corporate property, opportunities and information that has come into one’s possession as a director as belonging solely to the company and unavailable for the director’s use. Only if a director can demonstrate that the property or information does not belong to the company or is otherwise public, will the director be free to make use of it.
Duties to avoid conflicts of interest
Scope of duties
Given the special position a director holds in a company, the courts have developed strict rules about conflicts of interest.
There are three principal rules concerning conflicts of interest:
- the conflict rule: a director must not have a personal interest or an inconsistent engagement with a third party, except with the informed consent of the company’s shareholders;
- the profit rule: a director must not use their position for their own or a third party’s possible advantage, except with the informed consent of the company’s shareholders;
- the misappropriation rule: a director must not misappropriate the company’s property for their own or a third party’s benefit.
Those general rules are supplemented by various specific rules in the Act that apply in respect of conflict situations, most relevantly the duties not to misuse position or information (see section 4 above) and the obligation to disclose any material personal interests (see section 5.3 below).
The rules about avoiding a conflict of interest are underpinned by the main concept that a director must always put the company’s interests ahead of their own personal interests.
It is sometimes difficult for a director to assess whether a conflict (or potential conflict) exists, because a conflict of interest may be direct or indirect and the duty extends to requiring that the director does not put themselves into situations where they may have in the future a conflicting interest.
This is why the conflict duty applies only when there is a ‘real sensible possibility of conflict’ between a director’s personal interest and duty to the company, or an actual conflict between their duty to a third party and their duty to the company. Directors must consider the extent of the personal interest or other duty in each situation and whether this test is satisfied.
The essence of the rule is whether the director can bring an independent judgment to bear, or whether the conflicting interest or duty could reasonably be expected to divide his or her loyalties. Clearly, a director cannot make a decision on both sides of a transaction, or make a decision that affects one of his or her material financial interests.
The comments in section 4.2 above are also relevant to the practical application of the profit and misappropriation rules.
Obligation to give notice of material personal interests
Directors are required by section 191 of the Act to give (unless certain specific exemptions apply) notice to the other directors of material personal interests in matters relating to their company’s affairs. The notice can be a standing one, but must include details of the nature and extent of the interest and the relation of the interest to the company’s affairs. The notice must be given at a directors’ meeting as soon as practicable after the director becomes aware of their interest in the matter, and details of the notice must be recorded in the minutes of the meeting.
In addition to giving notice of the conflict, the conflict rule may require a director to abstain from participating in board discussions, and voting on board decisions, in relation to matters in which the director has a conflict of interest or duty.
However, the constitution of a proprietary company often relaxes the duty to avoid a conflict of interest. For example, constitutions frequently permit a director to vote at a board meeting on a contract or arrangement in which he or she is interested, as long as notice of the interest has been given to the other directors.
In some circumstances, disclosure of a conflict and abstaining from voting will be insufficient to satisfy a director’s duty. In this case, the director may be under a positive duty to take steps to safeguard the company’s interests. The action required will depend on matters such as the extent of the conflict, the extent to which the director has been involved in the transaction and the gravity of possible outcomes for the company. In some extreme cases, the only option available is for the director to resign.
Duty not to fetter discretions
Directors are under a duty not to place themselves in a position where they are unable to make a decision in the best interests of the company.
A director cannot allow a situation to arise that would mean that they have to put the interests of themselves or someone else ahead of the interests of the company. An example might be where the directors agree to allow the company to enter into a contract under which the directors agree to make future board decisions in a pre-determined manner.
Also, directors are under a duty to give adequate consideration to matters affecting the company. This effectively means that a director cannot be a ‘sleeping director’ who has no real involvement in the business and relies on management or other directors to run the business and comply with all legal requirements. It also means that the directors cannot simply act blindly at the direction of another person (including a controlling shareholder).
Summary of other specific directors’ duties
In addition to the basic duties of a director outlined in section 1 above, there are numerous other provisions of the Act that impose specific obligations on directors. Some of the potentially more relevant duties are summarised below.
Duty to prevent insolvent trading
Section 588G(2) of the Act imposes a duty on each director of the company to prevent the company from incurring a debt where:
- the company is insolvent, or becomes insolvent by incurring that debt (or debts including that debt); and
- the director is aware that there are grounds for suspecting that the company is insolvent (or would become so insolvent), or a reasonable person in the position of the director would be so aware, unless a defence applies.
There are also specific provisions (in sections 588J to 588M of the Act) under which the director may become personally liable to the company (including at the instigation of a liquidator) or to a third party creditor for the amount of the debt and any loss or damage suffered by the creditor in relation to the debt because of the company’s insolvency.
Duty to ensure compliance with financial record- keeping and reporting requirements
Section 344 of the Act effectively imposes a duty on directors to take all reasonable steps to comply with, and to ensure that the company complies with:
- Part 2M.2 of the Act, which sets out various financial record-keeping requirements; and
- Part 2M.3 of the Act, which sets out financial reporting requirements (for example, relating to the preparation, lodgement and issue of financial reports, directors’ reports and auditor’s reports). The application of these reporting requirements to individual companies varies depending on their type, size and circumstances, as well as the availability and conditions of any exemptions or modifications issued by the Australian Securities and Investments Commission (ASIC).
There are various other provisions in the Act that impose specific obligations on directors and officers. These include provisions prohibiting the falsification of records (section 1307) and the provision of false and misleading information (section 1309).
Consequences of breach of directors’ duties
Under Australian law, directors can be exposed to significant criminal and/or civil liabilities, or liability to pay compensation (damages), for a breach of their duties as a director.
The specific consequences of breach and available remedies vary depending on the particular duty and the source of the duty (that is, whether contractual, equitable or statutory).
Civil penalties for a breach of directors’ duties
The statutory duties of directors set out in section 180 (care and diligence), section 181 (good faith and proper purpose) and sections 182 and 183 (misuse of information or position) are all ‘civil penalty provisions’ of the Act.
Also, the duty to prevent insolvent trading under section 588G(2) of the Act and the duty to ensure compliance with financial record-keeping and reporting requirements under section 344 of the Act are both civil penalty provisions.
If director breaches a civil penalty provision, a court may order them to pay a pecuniary penalty to the Commonwealth of up to $200,000 where the contravention materially prejudices the interests of the company or its members, or materially prejudices the company’s ability to pay its creditors, or is otherwise serious. An application for a pecuniary penalty order can only be made by ASIC.
Criminal penalties for a breach of directors’ duties Section 184 of the Act imposes penalties for criminal offences in relation a breach of certain of the statutory directors’ duties as follows:
- breach of good faith and proper purpose duty: if the director is reckless or intentionally dishonest, and fails to exercise their powers and discharge their duties in good faith in the best interests of the corporation or for a proper purpose;
- breach of misuse of position duty: a director commits an offence if they use their position with intentional dishonesty in order to directly or indirectly gain an advantage for themselves, or someone else, or cause detriment to the company or recklessly as to whether the use of their position may result in any such advantage or detriment;
- breach of misuse of information duty: a person who obtains information because they are, or have been, a director of a corporation commits an offence if they use the information with intentional dishonesty in order to directly or indirectly gain an advantage for themselves, or someone else, or cause detriment to the company or recklessly as to whether the use may result in any such advantage or detriment.
Also, a director may also commit a criminal offence where they breach in a dishonest manner the duty to prevent insolvent trading under section 588G(2) of the Act or the duty to ensure compliance with financial record-keeping and reporting requirements under section 344 of the Act.
The maximum penalty for a criminal offence for an individual is 2,000 penalty units (currently totalling $340,000) or up to five years’ imprisonment, or both (per offence).
Damages under the Act for a breach of directors’ duties
A director who engages (or proposes to engage) in conduct that contravenes any of their duties or obligations under the Act may be ordered by a court to pay damages to any person whose interests have been, are or would be affected by the conduct (either in addition to or in substitution for the grant of an injunction).
This power is conferred by section 1324(10) of the Act, which supplements the general law rights of action affected persons may have for a director’s breach of statutory duty.
We note that this power may not apply to some civil penalty provisions. An application under section 1324 of the Act may be made by ASIC or any affected person.
Further, under section 1317H of the Act, the court may order a director to compensate the company for damage suffered by the company if the director has contravened a civil penalty provision in relation to the company and damage resulted from the contravention. An application for a compensation order can be made by ASIC or the company.
Disqualification from managing companies
Section 206C of the Act gives the court power to disqualify a person from managing companies (which includes being a director or an officer of a company) for a contravention of a civil penalty provision.
A director’s liability for offences committed by the company
The Act and many other statutes impose on directors (and others involved in management) personal liability for their company’s failure to comply with legislation. That personal liability can involve criminal or civil liabilities (or both).
However, there is no uniform approach adopted in Australian legislation to the circumstances in which a director can be exposed to such personal liability. In particular, there are a wide range of different statutory tests and methods for imposing personal liability on directors (or others involved in management) for a company’s contravention of the relevant statute.
In addition, under general criminal law principles and under certain statutory provisions (including the Commonwealth Criminal Code), directors can be exposed to liability commonly called ‘accessorial liability’. In very broad terms, this liability may apply to any person who intentionally or knowingly participates in a company’s commission of a criminal offence (or common law crime). Similarly, some statutory provisions apply accessorial liability in relation to a company’s civil liabilities (eg where a director meets a statutory test for involvement in the company’s contravention).
Identifying all Commonwealth, State and Territory legislation under which a director could be exposed to personal liability for the company’s conduct or liabilities would be a significant exercise and is not within the scope of this reference guide.
We note that, depending on the nature of a company’s operations, taxation laws, workplace health & safety laws and environmental laws can be sources of significant potential personal liability for directors and are therefore often areas of concern for some directors.
A director’s liability for breach of duty owed directly to third parties
In some circumstances, directors may also potentially become exposed to personal liability under the law of torts for tortious acts (or omissions) in connection with the conduct of the company’s business (including potentially jointly with the company).
Generally speaking, the most relevant tort in the context of this advice is the tort of negligence. In broad terms, this tort imposes liability on a person where it is reasonably foreseeable that another person would be injured by their action or inaction (giving rise to a duty of care), and that person suffers loss or damage as a result. For example, a director could become personally liable in negligence if their own action or inaction constitutes a breach of a duty of care they owe directly to a third party, or if they direct the company to engage in conduct which constitutes a breach of the company’s duty of care to a third party.
The law of negligence is very complicated and its application will depend on precise circumstances. For example, different rules apply where personal injury is caused, as distinct from pure economic loss.
Scope and limitations
This summary provides a general outline of the core and most relevant duties of directors of Australian proprietary companies under the Australian (Commonwealth) statute titled Corporations Act 2001 (Cth) (Act). It does not detail or generally set out all duties owed by directors under general law or statute.
This summary also notes the types of circumstances in which directors may become exposed to personal liability under the Act by virtue of their position as a director. It does not detail or generally set out all sources of potential liability for a director, nor does it cover liabilities a director may bear as an individual (as distinct from by reason of their position as a director) or in any other capacity such as an employee or a secretary.
As this is a summary only, it cannot be relied on for legal advice. It does not cover all of the different circumstances that might arise, nor does it seek to apply the law in any particular factual scenario.