Australia: The responsibilities of becoming a director

The Corporations Act 2001

The obligations of directors are based on the fact that they hold a position of fiduciary responsibility to the company or organisation of which they are a director.

The primary obligations are:

• Section 180(1) Corporations Act 2001 (the CA) imposes the obligation of acting with care and diligence¹.
• Subsection 180(2) deems an officer to have satisfied the requirements of S180(1), as well as the corresponding general law duty, where an officer has chosen to take or not take action based on an exercise of their judgment in:
• 1. good faith and for a proper purpose², and
  2. not for a material personal interest³, Though only in circumstances where:
  3. the officer informs themselves about the subject matter of the judgment to the extent he or she reasonably believes to be appropriate, and
  4. the officer rationally believes that the judgment is in the best interests of the corporation.
• Section 181(1) requires officers to exercise powers in good faith for what they believe to be the interests of the Company, and for a proper purpose.
• Section 182(1)(a) prohibits officers from acting in their position for the purpose of obtaining personal advantage for themselves or for another person⁴.
• Section 183 requires directors to refrain from using information obtained in the course of their duties for the advantage of themselves or for another person⁵.
• 1.1 Case Law

The care and diligence criteria found in Section 180(1) of the Corporations Act 2001 was discussed in ASIC v Vines where it was held that "each person appointed to a designated executive office is subject to objective statutory duties of care, skill and diligence measured by the degree of care, skill and diligence that a reasonable person in an equivalent executive position in the corporation would exercise in the corporation's circumstances⁶. It will be noted from this statement that the applicable standard is that of a reasonable person who is in the position of the director in the particular circumstances of the organisation. Thus, the standard of care required of a director will vary, though it is to be determined objectively.

It has been said that the standard of care required by the statutory duty is "no higher" than that required by the analogous general law duty⁷. Indeed, it has been said that the statutory duty is "essentially the same"⁸ as the general law duty.

Section 180(2) has been described as the "business judgement rule", which prevents a Court from enquiring as to the merits of a business judgement⁹. The components of Section 180(2) can be understood by reference to their general law meaning. For example, in Chew v R¹⁰, it was stated that the duty of good faith requires company directors to:

• act honestly (and not misappropriate the company's assets);
• exercise their powers in the interests of the company (and avoid misusing their powers); and avoid conflicts of interests¹¹

The requirement of Section 182 to act other than for material self interest reflects fundamental fiduciary obligation. It was said of the precursor to that section that the impropriety that is prohibited by it "consists in a breach of the standards of conduct that would be expected of a person in the position of the alleged offender by reasonable persons with knowledge of the duties, powers and authority of the position and the circumstances of the case"¹² At its base, the Section confirms the long standing rule that directors cannot use the power conferred upon them to obtain some private advantage¹³.

1. Basis of a director's fiduciary duties and classes to which they may apply

As a broad statement of principle, it has been said that a precondition for a person to be a fiduciary is that they 'must first and foremost have bound themselves in some way to protect and or to advance the interests of another'.¹⁴ This description is appropriate to describe the responsibilities of directors, namely to protect and advance the interests of the Company or organisation of which they are a director. For a director to seek personal advantage to the disadvantage of the Company or organisation of which they are a director is necessarily contrary to that objective.

There are two fundamental duties that exist for all fiduciaries including company directors. In the context of corporations law;

1. Directors may not profit from their position unless they have the Board's express informed consent.
2. Directors have a duty to avoid any conflicts of interest between themselves and the Company of which they are a director.

3. 1.3 Concept of material personal interest

Central to these obligations is the concept of "material personal interest". Section 191 of the Corporations Act requires a Director of a company who has a "material personal interest in a matter that relates to the affairs of the company" to give the other directors notice of that interest.

The expression is not defined in the Corporations Act nor is any of the component expressions such as "material" and "interest". Nonetheless, the expression was considered in Grand Enterprises Pty Ltd v Aurium Resources Ltd¹⁵. In determining that the relevant interests of the Director in that case did not have to be disclosed because they were "insubstantial and/or remote", Barker J, relied on an analysis of the expression undertaken by Murray J in McGellin v Mount King Mining NL¹⁶. In the McGellin case Murray J observed:

The law provides a defence to an allegation of breach of fiduciary duty where the alleged breach was perpetrated with the "fully informed consent" of the Company. In Maguire v Makaronis it was said that:

The question of whether information is "relevant" or "material" is, "in part, an objective one as to whether or not the information not available to the beneficiary is of relevance and of sufficient significance to the decision to grant consent, that that decision cannot be said to have been fully informed."²²

Moreover the onus of establishing fully informed consent is on the director who owes the fiduciary duty. That is, the requirement of disclosure is not dependent upon the director's subjective assessment of the "materiality of the information" (or the need to make disclosure). Rather, it is to be adjudged objectively from the standpoint of other members of the Board of Directors. In short it is the director who owes the fiduciary duty who bears the onus of proving that there was "full and frank disclosure of all material facts".²³

2. Factors determining fully informed consent

Sophistication of those to whom the duty is owed

Despite the imprecision of the formula, certain factors are relevant in determining the fact of whether fully informed consent has been given. In Farah Constructions Pty Ltd v Say Dee Pty Ltd the High Court of Australia considered whether the "the sufficiency of disclosure can depend on the sophistication and intelligence of the persons to whom disclosure must be made." That is the obligation may be less strict where he Board of Directors is sophisticated but more strict where other members of the Board are less knowledgeable.²⁴

Refraining from voting may not be sufficient

Further factors are relevant in determining the extent of the disclosure required, which will vary from case to case²⁵. In Fitzsimons v R, a case in which the applicant was the director of a number of companies to which he owed fiduciary duties, Owen J considered the factors relevant in determining the extent of disclosure required. His Honour considered that "the minimum requirement will be disclosure of the interest" and continued:

Special obligation on a Director who conducts the day to day operations of an Organisation

A director may be permitted to merely disclose a conflict of interest or abstain from the relevant exercise of power, thereby remaining in their conflicted position as if at arm's length. In other circumstances, though, a director may be subject to more onerous requirements. It has been held, in the context of company law, that where "...the director conducts the day to day operations of the company or is otherwise possessed of knowledge relevant to the decision, which his co-directors do not possess, he may not be free to act in that way but may be obligated to act in a way which protects the interests of the company"."²⁷

Director with special knowledge or appreciation of the relevant facts

Similarly, where a director has a better appreciation than their co-fiduciaries of the facts material to the wisdom of a particular transaction, a positive duty to protect the interests of the Company is occasioned²⁸. In these circumstances, the discharge of duty requires that the conflicted director to "at least" takes steps to "ensure that the other directors appreciated the potential harm inherent in the transaction."²⁹ It is insufficient in such circumstances to merely declare the existence of a personal interest or special knowledge³⁰.

Wilful blindness no protection

In Permanent Building Society (in liquidation) v McGee³¹, it was a director who knew of the financial state of another entity (owing to his substantial shareholding therein) to which the company loaned money was under a positive duty to disclose that knowledge. A fiduciary will not escape this more onerous obligation if they are not "possessed of knowledge" merely because of wilful blindness as to the relevant facts³². A director cannot "avoid that duty by, metaphorically speaking, burying his head in the sand while his co-directors discussed" enter into a "potentially detrimental transaction."³³

Extent of Power and influence relevant

In Permanent Building Society (in liq) v McGee it was further suggested that the "power and influence" of the director over the board and the capacity of that director to "prevent the transaction" cast upon him a positive duty to prevent the transaction³⁴. Thus, the relative influence and power of a director will further determine the extent of disclosure required, and indeed may impose a duty upon a fiduciary beyond mere disclosure. The fiduciary may, for example, be required to ""point out steps that could be taken to reduce the possibility of that harm"³⁵ or even, as indicated, take positive steps to prevent the exercise of the power in a particular way³⁶.

Timing of disclosure

The timing of purported disclosure may also be of relevance. If by failing to disclose the relevant facts at a particular time a director "sets the course" for the transaction or exercise of power that is said to be in breach of fiduciary duty, they are unlikely to escape liability by making that disclosure at a later time³⁷. Finally, "the gravity of the possible outcome" of the exercise of the power alleged to occasion the breach of fiduciary duty will affect the extent of the disclosure required to ground a defence of fully informed consent³⁸.

3. Ratification of breach of fiduciary duties of Directors

A breach of fiduciary duty may be ratified or approved either retrospectively or even prospectively (in the case of a planned breach) provided certain conditions are met.

Where there has been a breach of fiduciary duty, or where a breach of fiduciary duty is proposed, provided that there has been full and frank disclosure, it is possible to be ratified by the Board or by a general meeting of shareholders, depending upon the person who is involved in the breach.

In Queensland Mines Ltd v Hudson, the Privy Council confirmed that it is possible for the board to ratify the decisions of a single director, provided that there has been full disclosure. It may not however be possible to notify a breach of duty committed by an entire Board (Regal (Hastings) Ltd v Gulliver).

There are limits upon the extent to which the general meeting can ratify breaches of duties of directors, especially when a corporation is in serious financial difficulty. Justice Santow in Miller v Miller summarised the circumstances in which ratifications would not be available:³⁹

1. Where it constitutes fraud on the minority⁴⁰
2. Misappropriation of company resources⁴¹
3. Entered into by an insolvent company to the prejudice of creditors⁴²
4. Defeated a member's personal right⁴³
5. Where the majority in the general meeting acted for the same improper purpose as the directors⁴⁴

Footnotes

¹Section 180(1) of the Corporations Act 2001: ASIC v Vines (2003) 48 ACSR 322; Company, Corporate & Securities Law, Australian Corporations Commentary, OFFICERS AND EMPLOYEES , DIRECTORS' AND OFFICERS' DUTIES , Other duties , [¶42-710] Duty of care and diligence.
² Sections 180(2) and section 181(1) of the Corporations Act: Chew v R (1991) 5 ACSR 473.Also see a useful discussion generally in Company, Corporate & Securities Law, above n3 [¶42-220] Equitable duty of good faith and in the interests of the company.
³ss180(2)9b) of the Corporations Act 2001. See also Mills v Mills [1938] HCA 4; (1938) 60 CLR 150 (17 February 1938) and Hindle v John Cotton (1919) 56 Sc.L.R625.
⁴ s 182(1) (a) of the Corporations Act. Fundamentally it confirms that directors cannot use the power conferred upon them to obtain some private advantage: Mills v Mills above.
⁵ This obligation reflects s183 of the Corporations Act.
⁶ASIC v Vines (2003) Supra; Company, Corporate & Securities Law, Australian Corporations Commentary, OFFICERS AND EMPLOYEES , DIRECTORS' AND OFFICERS' DUTIES , Other duties , [¶42-710] Duty of care and diligence
⁷ Redmond, P. Corporations and Financial Markets Law (6^th Ed), Sydney, Thomson Reuters, 2013, p. 432.
⁸ ASIC v Rich (2009) 75 ACSR 1 per Austin J at [7254].
⁹See generally Redmond Supra, pp. 457-463.
¹⁰ (1991) 5 ACSR 473
¹¹ See useful discussion generally in Company, Corporate & Securities Law, above n3 [¶42-220] Equitable duty of good faith and in the interests of the company
¹²Byrnes v R (1995) 183 CLR 501 at [514] per Brennan, Deane, Toohey, and Gaudron JJ; See also: Hindle v John Cotton (1919) 56 Sc.L.R.625
¹³Mills v Mills (1938) 60 CLR 150
¹⁴ Finn P, Fiduciary Obligations (Law Book Co, 1977).
¹⁵[2009] FCA 513 (28 May 2009)
¹⁶(1998) 144 FLR 288
¹⁷ This section is based substantially on a lecture presented by my colleague, Selwyn Black to the University of NSW Law School in September 2014.
¹⁸ Maguire and Anor v Makaronis and Anor (1997) 144 ALR 729, per Brennan CJ, Gaudron, McHugh and Gummow JJ at 739.
¹⁹ Queensland Mines Ltd v Hudson (1978) 52 ALJR 399.
²⁰Fyffes Group Ltd v Templeman [2000] 2 Lloyd's Rep 643 at 668–70
²¹Re Paulings Settlement Trust [1962] 1 WLR 86 quoted with approval in Maguire (supra).
²²Fexuto Pty Limited v Bosnjak Holdings Pty Limited & Ors [2001] NSWCA 97 per Spiegelman J at 122.
²³ New Zealand Netherlands Society "Oranje" Inc v Kuys [1973] 1 WLR 1126 per Lord Wilberforce at 1131–1132, quoted in Hurley v BGH Nominees Pty Ltd (No 2) (1984) 37 SASR 499; 10 ACLR 197 at 202.
²⁴ Ibid.
²⁵ Phipps v Boardman [1967] 2 AC 46 at 124 per Lord Upjohn; Fitzsimmons v R (1997) ACSR 355, per Owen J in the Court of Appeal of WA at 358.
²⁶ Fitzsimmons supra
²⁷ Centofanti v Eekimitor Pty Ltd (1995) 15 ACSR 629 per King CJ at 632
²⁸ Permanent Building Society (in liq) v McGee (1993) 11 ACSR 260, at 289-90; See also: Australian Breeders Co-operative Society Ltd v Jones & Ors (1998) 16 ACLC 100.
²⁹ Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187: Permanent Building Society (in liq) v McGee (1993) 11 ACSR 260, 289-90:
³⁰ Groeneveld Australia Pty Ltd v Nolten (No 3) (2010) 80 ACSR 562 at 577 per Davies J.
³¹Permanent Building Society (in liq) v McGee supra.
³² Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 398.
³³ Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187 at 161.
³⁴ Permanent Building Society (in liq) v McGee supra at 289-90; see also ASIC v Adler and ORS [2002] NSWSC 171 at [735] (upheld on appeal to the NSW Court of Appeal).
³⁵Permanent Building Society v Wheeler Supra; see also Fitzsimmons v R (1997) ACSR 355, Owen J in the Court of Appeal of Western Australia stated (at 358)
³⁶ASIC v Adler, supra; Permanent Building Society (in liq) v McGee, supra at 289-90:
³⁷ Duke Group Ltd (in liq) v Pilmer (1999) 31 ACSR 213, at [672] (reversed on appeal to the High Court of Australia).
³⁸ Fitzsimmons supra per Owen J in the Court of Appeal of W A at 358:
³⁹ Miller v Miller (1995) 16 ACSR 73 at 89.
⁴⁰ Ngurli Ltd v McCann (1953) 90 CLR 425.
⁴¹ Hurley v BGH Nominees Pty Ltd (1982) 6 ACLR 791.
⁴² Kinsella v Russell Kinsella Pty Ltd (in liq) (1986) 4 NSWLR 722.
⁴³ Residues Treatment & Trading Co Ltd v Southern Resources (No 2) (1988) 14 ACLR 396.
⁴⁴Ibid.