Put simply, directors’ duties are the obligations which fall to any person who takes on or becomes a director of a company or corporation. These duties can continue even after a company has stopped operating and even after deregistration.
The law which governs directors’ duties in Australia is the Corporations Act 2001 (Cth) (‘Corporations Act).
The main purposes of creating a company are:
- to limit the risk of loss of personal assets
- to limit tax liability, and
- to protect individuals from personal liability.
These can be achieved through the creation of a company because it is considered a separate legal entity. Further, an entity in the form of a company has a potentially unlimited lifespan and can exercise rights in the same way as a person.
However, although there are many obvious benefits to creating a company, if you will become a director, you must first be aware of the legal duties and obligations attached to such a position. A breach of any of these duties can have a severe impact on a person’s profession, finances, and lifestyle if the breach or breaches are serious.
‘Director’ is defined in s 9 of the Corporations Act as a person who:
- ‘is appointed to the position of a director’, or
- ‘is appointed to the position of an alternate director and is acting in that capacity’.
Generally speaking (subject to the exceptions below), the person’s appointment must be valid and in accordance with the legislation.
The Corporations Act provides for multiple directors, but sole directors are also permitted for proprietary limited (Pty Ltd) companies. These directors have the capacity to exercise all company powers.
Even if a person has not been validly appointed as a director, in some circumstances, they can still be deemed a director and to have taken on all the duties and obligations normally ascribed to a director (s 9(b) of the Corporations Act). This may arise where they act in the position of a director, or the directors of a company are accustomed to acting in accordance with their instructions, unless it is evident that this was not the intention, such as where the person:
- does not have the power to call company meetings
- does not sign minutes of meetings, or
- has been described in a notice to ASIC that the person has ceased being a director.
In situations where a person has not been officially appointed as director but exercises functions similar to those of a director (as per the s 9(b) definition), they will be deemed a ‘shadow’ or ‘de facto’ director:
- A ‘shadow director’ is ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’ – the person is held out by the company as a director and purports to be a director of the company without being validly appointed; and
- A ‘de facto director’ is a person ‘who assumes to act as director without having been appointed validly at all’. Unlike a shadow director, the person does not hold themselves out to be a director and is not held out by the company as being a director; he or she ‘lurks in the shadows’.
Liability does not depend on the validity of a director’s appointment, and those who exercise power and discharge functions as a director must accept the responsibilities attached to the office (see Re Hydrodam (Corby Ltd)  2 BCLC 180).
Australian courts have held that, when determining whether a person is a director in circumstances where they have not been validly appointed, it is a question of fact and degree; it is necessary to look at all relevant factual circumstances. However, one necessary condition is that the person exercised ‘actual top management functions’ (DCT v Austin (1998) ACSR 565, 567).
The duties and obligations of directors under the Corporations Act are extensive. However, the basic duties which apply are the duties to:
- avoid conflicts of interest
- act in good faith and for a proper purpose
- exercise due care and diligence, and
- prevent insolvent trading.
Directors are obliged by s 191(1) of the Corporations Act to disclose any interests of a personal nature that will or may conflict with those of the company. While not an issue for sole directors, in any other case, this means that a director is not permitted to have an interest in any dealing unless full disclosure as to the nature of the dealing is made to members of the company at a general meeting and it is approved by way of ordinary resolution. The dealing could relate to, for example, a contract, trust, or transaction.
Section 181(1)(a) of the Corporations Act requires that all directors act in good faith. Again, this is less likely to be problematic for sole directors, but for anyone else, the provision means that directors must act ‘bona fide’ or genuinely in the best interests of the company.
When the company is solvent, the company’s interests concern its members. When the company is insolvent, or likely insolvent, the interests shift to its creditors. However, this does not mean that a separate duty is owed to creditors. Rather, the duty to take into account creditor interests merely restricts the right of shareholders to allege breaches of the duty to act in good faith (Spies v The Queen (2000) 201 CLR 603, 636; Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler (1994) 51 FCR 425, 444-5).
The duty to exercise care and diligence (s 180 Corporations Act) provides that directors must take reasonable care when performing functions of their office. This is determined objectively and takes into account the skills of the director at the time.
|Example: If the director is an accountant, the standard of care will be raised for any decision that falls within the scope of their expertise as an accountant.|
Even if the director does not have specific expertise, the important thing to remember is that the director must take ‘reasonable steps’ to put themselves in a position where they are aware of all aspects of the company in order to effectively manage it.
|Example: It is not enough for the director to say that they did not understand documents relating to the company’s financial position. They must put themselves in a position so that they do understand, whether that means they need to, for example, engage an accountant to interpret the information.|
The duty of a director to prevent insolvent trading is probably the most important of all duties. Under s 588G of the Corporations Act, a director breaches the duty if they do not prevent their company from incurring a debt whilst insolvent, or whilst there are reasonable grounds to assume that the company is likely to be insolvent.
|What is a debt? A debt generally means an obligation to pay another person or entity a sum of money.
What does insolvent mean? To be insolvent means that the company cannot pay their debts when they become due and payable. However, it is important to note that when calculating whether a company can meet its debts, it does not just refer to monies available, but the overall liquidity of the company. This means that all real and liquid assets of the company will be taken into account (anything a company can sell to pay off their debts).
If this duty is breached, the director may become personally liable. This is one instance where the ‘corporate veil’ can be pierced; the fact that the company is a separate legal entity will not necessarily protect the director from personal liability.
The consequences of a breach of a directors’ duty will vary depending upon which duty has been breached and what has occurred as a result of that breach.
Generally speaking, the consequences could be:
- personal liability for debts, financial losses, or outstanding tax obligations
- criminal conviction for offences which carry a maximum penalty of $200,000, 5 years in prison, or both
- a civil penalty whereby you must pay the Commonwealth up to $200,000
- personal liability for compensation to the company or to anyone else who suffers loss or damage as a result of the breach
- ineligibility for managing another company in the future.
This article reflects the state of the law as at 31 May 2016. It is intended to be of a general nature only and does not constitute legal advice. If you require legal assistance, please telephone 1300 636 846 or request a consultation at gotocourt.com.au.