Directors' duties

The relationship between a director and a company is fiduciary in nature, meaning that a director undertakes to act in the interests of the company and not in their own interests.

The overriding priority among the fiduciary duties of directors is the obligation of undivided loyalty. This obliges the director to act honestly, in good faith and to the best of his or her ability in the company’s interests. A director must not allow personal advantages to override the company’s interests. The organisation must always come first.

While boards are often said to make collegiate decisions for which they take collegiate responsibility, the law – through both the Corporations Act 2001 (Cth) (Corporations Act) and the common law – imposes individual duties on both executive directors and non-executive directors.

What are my core director duties under the Corporations Act 2001 (Cth)?

To act with care and diligence

Directors must discharge their duties with the degree of care and diligence that a reasonable person would exercise if he or she were a director in the company’s circumstances and had the same responsibilities of that director.

Whether a director has exercised a reasonable degree of care and diligence is determined by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected.

The business judgment rule provides a defence for directors in relation to an alleged breach of this duty. This rule seeks to avoid unnecessary restrictions on proper entrepreneurial activities.

To act in good faith in the best interests of the company and for a proper purpose

The ‘company’ (as a distinct legal and commercial entity) is the focus of this duty and it requires consideration of more than financial returns.

Boards operate in a complex environment and must have sufficient flexibility to consider what the best interests of the company are in the context of specific decisions, exercising appropriate judgment.

In practical terms, acting with ethical corporate social responsibility towards stakeholders (such as customers, employees, community and the environment) is necessary for the promotion of the interests of the company and its sustainability, and builds long-term value for shareholders.

In his Final Report Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Commissioner Hayne discusses the consideration by boards of stakeholder impacts when acting in the best interests of the corporation:

“The longer the period of reference, the more likely it is that the interests of shareholders, customers, employees and all associated with any corporation will be seen as converging on the corporation’s continued long-term financial advantage.”

To not improperly use information or position

Directors must not improperly use their position, or information they obtain because they are or have been a director, to gain an advantage for themselves or someone else, or cause detriment to the company.

To manage conflicts of interest

A director must avoid or appropriately manage conflicts between personal interests and the company’s best interests. He or she must disclose – to other directors of their company – the nature and extent of matters relating to the affairs of the company in which he/she has a material personal interest.

To prevent insolvent trading

It is a role of the board of directors to ensure that a company does not trade while insolvent or where they suspect it might be insolvent. Directors will be personally liable for certain debts which are incurred if:

• they are a director at the time when the company incurs the debt;

• the company is insolvent at that time, or becomes insolvent by incurring that debt; and

• at that time, there are reasonable grounds for suspecting that the company is insolvent or would become insolvent.

An insolvency safe harbour protection is available for courses of action that are reasonably likely to lead to a better outcome for the company.

In the spirit of untethering entrepreneurial risk-taking from black-letter director duty, the government responded to the COVID-19 economic crisis in March 2020 by providing a six-month relief for directors from personal liability for trading while insolvent.

Statutory duties in relation to financial record keeping and reporting

Directors have an obligation to take reasonable steps to ensure that their company complies with its obligations under the Corporations Act in relation to the keeping of financial records and financial reporting.

Provision of director information

Directors have an obligation to provide to their organisation, and in certain circumstances to the Australian Securities and Investments Commission (ASIC), information relating to themselves.

What are the consequences of breaching directors’ duties?

Criminal and civil sanctions

Contravention of certain duties under the Corporations Act or other laws can constitutes a criminal offence or/and can make a director liable to a substantial fine.

Disqualification

Both ASIC and the courts have the power to disqualify directors for long periods of time for failure to comply with their duties under the Corporations Act.

Commercial consequences

The most serious consequences of breaching directors’ duties are often not the legal ones but the commercial ones. A corporation’s most valuable asset is its reputation. The company will likely be subjected to much greater scrutiny, both by investors and regulators, where directors breach duties.

What rights do directors have?

The rights of directors focus on enabling them to effectively perform their duties while being a director of an organisation. They also focus on allowing them to defend themselves in legal proceedings after ceasing to be a director of that organisation.

Directors can obtain insurance against liability for breach of duties in certain circumstances, but they cannot obtain insurance for certain breaches of the Corporations Act (or even other relevant legislation). A deed of indemnity (between an organisation and a director) can help to indemnify a director against liabilities or legal costs incurred in his or her professional capacity as a director of the company. It’s important to have appropriate directors’ and officers’ insurance (D&O insurance), especially as a claim by a director for indemnity will be of little assistance if the company does not have sufficient funds to meet the claim.

Director identification numbers

In one of the latest developments in director obligations - the new Commonwealth Modern Business Registry Regime – all directors will be issued with unique director identification numbers (Director IDs). The Director IDs will be kept permanently and provide traceability (subject to the removal of sensitive personal information) of a director’s profile and relationships across companies over their career. Significant penalties will apply to those who fail to hold a Director ID or seek to circumvent the regime. The new regime is expected to be rolled out in the first half of 2021.