directors duties with flow chart, Cheat Sheet of Law

Download directors duties with flow chart and more Cheat Sheet Law in PDF only on Docsity! WEEK – 10 DIRECTOR’S DUTIES Because shareholders of a company cannot interfere with the management of the company the common law and statue law imposes duties on company officers to ensure they act in the best interest of the company. The key duties of directors and officers are as follows:  Act with care and diligence  For directors only, avoid allowing the company to trade while the company is insolvent.  Be a fiduciary; that is, be loyal and faithful to the company first, and avoid conflicts of interest. OFFICER’S DUTIES There are 2 distinct groups in a company: owners and managers. Managers are obliged to manage the company in such a way that benefits the owners. However, under both the case law and statue, owners cannot interfere with the management of a company. It is up to the officers as managers to decide how to achieve the company’s business goals. An officer’s duties must be understood to both: A positive act – what officers should do and A negative act – what officers should not do. Directors of a company have 2 liabilities regarding their activities. The first liability is to the company. Under the law of agency, a director who is an agent has a contract with the principal and the company. If there is breach of that contract then the principal, and the company can take action against the director. The principal is concerned about the compensation for the company. In addition, directors have responsibility under the Corporations Act. The application of common law will be where the company takes action against the officers of the company. It is established in common law that officers have a duty to: I. Be a fiduciary.  Avoid conflicts of interest  Act in good faith in the interest of the company, and  Use their powers for a proper purpose, and II. Act with reasonable care and diligence. When these duties are breached and harm is caused to the company, the company can take legal action. It will seek to “undo” the effects of the breach. The main remedy in this situation will be damages payable to the company by the defaulting officer, but there are other general law remedies that may suit, for example: an injunction to stop an officer from further breach. Be a fiduciary: a fiduciary has a duty to use their power in the interests of the person to whom they owe the duty. Fiduciaries have specific duties to be loyal to the company and to retain discretions. A fiduciary owes a duty of loyalty to the company. To be loyal a fiduciary must:  act in good faith  not make profit out of their position,  not place themselves in a position where their duty and their interest conflict, and  not act for their own benefit or the benefit of a third person without the informed consent of the principal. Officers also have a fiduciary duty to retain discretions. This means where officers have a duty to act in the interest of the company, they should not limit the power by acting in the interest of a controlling or influential shareholder. Act with reasonable care and diligence:  the minimum standards established in common law, required of all officers are to –  be familiar with the company’s business and financial position.  be aware of other areas of the company outside your own area of expertise,  monitor management,  enquire and seek information by attending meetings and asking questions, and  not ignore corporate misconduct. DUTIES UNDER THE CORPORATIONS ACT The statutory duties imposed by the Corporations Act are:  Act with reasonable care and diligence – s 180  Prevent insolvent trading – s 588G.  Act in good faith in the best interests of the company and for a proper purpose – s181  Not misuse position – s 182  Not misuse information – s 183  Disclose certain material interests – s 191.  Disclose to other officers and vote (proprietary companies) – s 194.  Disclose and not able to vote (public companies) – s 195, and 2 III. Delegate only to capable, experienced, qualified, and reliable persons.  Delegation can be to the managing director.  Delegation to staff must only be to staff capable of the responsibilities. IV. Be familiar with financial status of the company by reviewing financial statements.  Understand the income statement and the statement of financial position.  Understand the impact of numbers on ratios and covenants and do comparisons to the previous year’s results. V. Make sufficient enquiries to inform business decisions.  Ask questions and obtain advice.  Ignorance cannot be used as a defense for business decisions.  A failure to enquire is no defense. VI. Do not ignore any misconduct of the company. Do not ignore knowledge and suspicion that the company is engaged is misconduct. VII. Pay attention to all areas of the company. Even if an officer is engaged for a particular skill, they must also pay attention to other areas of the company. THE STANDARDS OF CARE BY TYPES OF OFFICERS Executive director – An executive director is considered to have a higher level of skill given they are involved in the day-to-day running of the company. They are expected to exhibit a higher standard of care than other directors. The test of standard of care of an executive director is what a reasonable person in the same position would do. Non-executive director – A non-executive director is not expected to have the same level of skill than an executive director. Non-executive directors are usually brought in as a director for some particular expertise, but they are not immersed in the day-to-day operations of the company. The chair – The chair of the board of directors is subject to a higher degree of standard of care in terms of their special responsibilities, including overseeing the general performance of the board and ensuring the flow of financial information to the board. The managing director/ chief executive director – The managing director or chief executive officer has overall responsibility for the day-to-day management of a company’s business and thus is subject to a relatively high standard of care. DILIGENCE All officers must be diligent when looking after the affairs of the company. Diligence is about understanding the affairs of the business, taking proactive steps to be informed, seeking professional advice on matters beyond the board’s experience or expertise and proposing issues and questions on matters before the board. Diligence is about obtaining general and specialist knowledge about being a company director and about the company’s business industry. The principle of diligence recognizes that officers cannot do everything, and that tasks or responsibilities can be, and will be, delegated. Delegation imposes a responsibility on the director who is delegating to ensure that the people they delegate to have the appropriate skill to handle the delegated task. 5 A director is able to rely on information and advice provided by others (s 189) as long as:  If from an employee — the director has reasonable grounds to believe the employee is reliable and competent.  If from a professional expert — the director believes that the expert has the skills required.  If from another director — the director believes the other director has the skills required.  If from a committee — the director believes the committee has the skills required. DEFENCES AGAINST A BREACH OF DUTY OF CARE AND DILIGENCE If a director or officer is found to not have acted with care and skill, they have a potential defence against that allegation. The defence is called the business judgement rule. This defence arises from the fact that the courts will not review the merits of a business decisions. In other words, the court will generally not interfere with a business decision made by company officers. The court will consider:  why the officer took the action,  whether the action was intended to benefit the company or intended to benefit the officers, and  the level of experience and knowledge pf the officer making the decision that caused harm to the company.  Business judgement rule: • A defense in common law and statute under s 180(2) that relies on the principle that the court will not review the merits (good or bad) of a business decision. • The rule recognizes that managers operate in an environment of uncertainty. USING THE DEFENCE The business judgement rule defence in s 180(2) of the Corporations Act only applies whether there is a breach of duty of care under s 180(1). The requirements to rely on s 180(2) as a defence. The defence will only apply if the director rationally believes that the judgement is in the best interests of the company. THE DUTY TO PREVENT INSOLVENT TRADING The company may become insolvent – it is unable to pay its debts. Officers are required to act in good faith and in the interests of the company. This has been held by the courts to be in interest of the members. However, when a company is insolvent, they duty owed by officer’s shifts from being owed to the members to being owed to creditors/suppliers. THE DUTY TO PREVENT INSOLVENT TRADING UNDER s 588G OF THE CORPORATIONS ACT Section 588G of the Corporations Act imposes a duty on directors, but not on other officers, to prevent insolvent trading. The purpose of the statue is to help future unsecured creditors. Secured creditors are generally in a stronger position if the company fails to pay them. Section 588G is a statutory example of removing the corporate veil. The purpose of s 588G is to protect future creditors after the company is insolvent. DIRECTORS LIABILITY FOR INSOLVENT TRADING 6 If all the conditions are met, then the directors of the company will be liable for the debts of the company that cannot be paid by the company. It should be noted that this liability only actually arises when the company is in liquidation, so the liquidator typically enforces the duty on behalf of the company and its creditors. DEFENCES TO A BREACH OF s 588G The defences to a breach of a 588G are contained within s 588H: It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the person – a) Had reasonable grounds to believe, and did believe:  that a competent and reliable person was responsible for providing to the first mentioned person adequate information about whether the company was solvent; and  that the other person was fulfilling that (responsibility; and b) expected, on the basis of information provided to the first mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in management of the company. It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt. PENALTIES AND REMEDIES Where there is a breach of s 588G of the Corporations Act, the following penalties and remedies can apply: 7