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Directors' Duties Notes

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This is an extract of our Directors' Duties document, which we sell as part of our Corporations Law Notes collection written by the top tier of Monash University students.

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Topic 8 and 9: Directors Duties NB: If there is a breach of director's duties, link to 232 (oppressive conduct) Corporate governance is: "the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations. It encompasses the mechanisms by which companies, and those in control, are held to account. Corporate governance influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimised." ASX Corporate Governance Council, Corporate Governance Principles and Recommendations with 2010 Amendments (2nd Edition) Duties:

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Duty to prevent insolvent trading

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Duty to act in good faith and in the best interests of the company

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Duty to use powers for proper purposes

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Duty to retain (not fetter) discretions

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Duty to avoid actual and potential conflicts of interest

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Duty to use care, skill & diligence of a reasonable person in like circumstances

Introduction

1. Identify who is subject to the duties on the facts: a. Under statue 9 both directors (includes de facto and shadow) and officers can be liable b. Extends to errors and mistakes and is not confined to procedural irregularities i. Director: person validly appointed to position of D 9(a)(i) ii. Officer: another person who makes/participates in making decisions which affect the whole or a substantial part of the company's business 9(c)(i) or a person who makes decisions that affect financial standing 9(c)(ii) iii. Employee: also liable in limited circumstances

2. Identify the legal basis of the duty a. ASIC/company can bring a claim both at general law and under statute as the two claims operate side by side 185 b. Whilst the general law and statutory duties govern similar conduct, statutory duties are more favourable for several reasons i. The statutory duties are wide in scope as they apply to employees, officers and directors ii. The statutory consequences are broader because ASIC has the power under statute to seek remedies under 1317E, such as disqualifying a director and can attempt to impose criminal liability 184 whereas X is restricted to compensation orders at general law (but can take advantage of equitable principles such as tracing) iii. Statutory breaches cannot be ratified, so D's have less scope to avoid liability c. However, you should still look at both given the difference in remedies available

Duty to Act in Good Faith in the Best Interests of the Company a. Statutory and fiduciary duties are exactly the same. Acknowledge that it has two different sources i.

Statutory: owed by directors and officer to the company

ii. Fiduciary: owed by people in a position of trust to beneficiaries of that trust

b. First question: is this person a director, de facto director, shadow director or officer? 9 A director will breach their duty if they permit or allow the corporation to contravene the act and: ASIC v Maxwell

* They company's interests were jeopardised

* The risks to the corporation outweighed any potential countervailing benefits and

* There were reasonable steps that could have been taken to avoid those risks c. Nature of the duty iii.

Civil offence s181: (1) A director or other officer of a corporation must exercise their powers and discharge their duties:

* (a) in good faith in the best interests of the corporation; v. Criminal offence s184(1) A director or other officer of a corporation commits an offence if they:

* (a) are reckless; or

* (b) are intentionally dishonest; and fail to exercise their powers and discharge their duties:

* (c) in good faith in the best interests of the corporation vi. Fiduciary duty

* Fiduciaries 'must exercise their discretion bona fide in what they consider --- not what a court may consider --- to be the interests of the company, and not for any collateral purpose' Re Smith and Fawcett Ltd (1942) d. Good faith (bona fide) vii. Whether something was in good faith is an objective test: Directors must subjectively think it, but it must be a belief that another director would reasonably hold. ASIC v Adler viii. The objective overlay is to overcome the:

* Dishonest director

* Amiable lunatic: "Bona fide (good faith) cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying its money with both hands in a manner perfectly bona fide yet perfectly irrational Hutton v West Cork Railway Co ix. Surrounding circumstances (objectively viewed) could lead one to doubt, discount or not accept a director's assertion he/she has acted in good faith Bell Group Ltd (in liq) v Westpac Banking Corporation x. What is motivating the accused? Is it the interests of the company or something else?

* Bring in evidence of this wrongful intention e.g. nondisclosure, failure to follow normal procedure, causing material prejudice to company Adler e. Best interests of the corporation: What are the interests of the company?
xi. Look at the CC: It may state the company's interests. Whitehouse xii. Corporation:

* shareholders as a collective group Greenhalgh v Ardene Cinemas Ltd

* Can consider the interests of other people/groups (stakeholders) provided doing so also benefits the company o But if shareholders' interests and interests of other groups conflict, shareholders' interests are paramount Darvall v North Sydney Brick & Tile Co Ltd (1989) iv.

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o Employees: no duty is owed, only to the extent that it will maximise company value Parke - where there is a conflict between the interests of shareholders and employees, shareholders will prevail Examples of actions that are not in the interests of shareholders: o Insolvent trading Bell Group Ltd (in liq) v Westpac Banking Corporation o Converting unsecured loans into secured loans, putting the best interests of the parent company and bank ahead of shareholders Bell Group Ltd (in liq) v Westpac Banking Corporation However exception when company is insolvent: o where the company is in financial difficulties, the creditors' interests become increasingly important Kinsela v Russell Kinsela Pty Ltd o does not confer a right of action on creditors to being an action for breach Spies v R Individual shareholders: o directors owe fiduciary duties to the company and not individual shareholders Percival v Wright (1902) o UNLESS: there is a direct and close relationship of trust, confidence and specific dependence (most likely in small; family companies) Examples: i. Director makes representation to shareholders about accepting an offer Coleman v Myers; Brunninghausen

1. This case contained: family character of the company

2. High degree of insider knowledge

3. Manner in which D went about persuading shareholder to sell ii. Transaction is between a director and shareholder, rather that the company and a third party Brunninghausen

1. Where offer is made, D must not us knowledge to his benefit over another. Requires the D to promote loyally the joint interests of all shareholders. o W while directors are required to act in the interests of the company, if they are also shareholders, they cannot reasonably be expected to disregard their interests Mills v Mills Interests in a corporate group: o Generally Ds cannot act in the interests of other companies in the group, only in the interests of that particular company Walker o Exception: If it a wholly owned subsidiary, Director may act in the interests of the HC where: i. CC of subsidiary expressly authorised D to act in the best interests of the holding company 187(a) ii. D acted in good faith and in the best interests of the holding company 187b iii. Subsidiary is not insolvent at the time D acts (and has not become insolvent from that act) per 187(c) o Exception: applies if not a wholly owned corporate group: i. Per Equiticorp (obiter) it was suggested that the interests of the related company may be taken into account where acting in the interests of other group members, objectively viewed, may be for the benefit of their own company (or no consequence would follow) despite a technical breach of duty Nominee directors: o Might have a contractual interest to act in the best interests of the company that nominated them. Will have to find a way which satisfies both duties o Where the interests of a holding company and the subsidiary's minority shareholders do not coincide, NDs appointed are bound to put the interests of the subsidiary's shareholders ahead of the majority shareholders Scottish Coop Wholesale Soc Ltd v Meyer

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o If they can't simultaneously satisfy them, they must resign one of their commission or run the risk of breaching the duty o Company's constitution may permit a nominee director to act in interests of nominator Levin v Clark (1962) Conclusion: if statutory duty is satisfied, so is fiduciary

Duty to act for a proper purpose a. Statutory and fiduciary duties are exactly the same. Acknowledge that it has two different sources xiii.

Statutory: owed by directors and officer to the company

xiv. Fiduciary: owed by people in a position of trust to beneficiaries of that trust

The onus of establishing that the directors acted improperly rests with those alleging the breach of duty: Australian Metropolitan Life Assurance v Ure xvi. A director may be in breach even though they are not involved in a particular transaction: The duty is breached if the director disclosed a conflict of interests and abstained from voting but knew of the improper purpose of the other directors and failed to take steps to prevent the transaction from proceedings. They are under a positive duty Permanent Building Society v Wheeler xvii. A director will breach their duty if they permit or allow the corporation to contravene the act and: ASIC v Maxwell

* They company's interests were jeopardised

* The risks to the corporation outweighed any potential countervailing benefits and

* There were reasonable steps that could have been taken to avoid those risks xv.

b. Nature of the duty xviii.

Civil offence 181: (1) A director or other officer of a corporation must exercise their powers and discharge their duties:

* (b) for a proper purpose

c. Question one: what was the power exercised?
d. Question Two: was it exercised for a proper purpose?

xix. Follow the test from Howard Smith v Ampol Petroleum as an objective test Whitehouse v Carlton Hotels

* As a matter of law, what are the purposes for which the power may, or may not, be exercised?

* As a matter of fact, for what purposes were the powers exercised in the particular case?
o Did D honestly believe he was acting for the proper purposes of [facts] and was it reasonable?
o Note: Honest and altruistic behavior by directors will not prevent a finding of improper conduct on their part if that conduct was carried out for an improper purpose. Wheeler o Motivation and purpose are separate: Motivation, even if in good faith, is not important if you have done it for an improper purpose Howard Smith

* If the factual purpose is within (one of) the permitted legal purposes - exercise is not in breach of the duty.

xx. If there are mixed purposes: Apply either the 'substantial purpose' test or the 'butfor' test (Acknowledge that there is two but state that the but for test is to be applied in Victoria)

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But for test per Whitehouse (HCA) which was followed in Wheeler

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'but for' the improper purpose the D wouldn't have acted

o Irrelevant whether the improper purpose was a dominant/one of a number of contributing causes o An improper consideration subordinate to a proper consideration that triggered the action would be acceptable xxi.

xxii. Examples of proper purposes:

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Raise capital/funds

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Provide consideration for a purchase

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Part of employee remuneration

Examples of improper purposes

* Maintain control of a company and maintain their position of control Ngurli v McCann

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Defeat a takeover bid o Note: they will not breach duties if they engage in defensive measure designed to maximise value of shares or advance the commercial interests of the company o Defeating a takeover bid is ok if it is prompted by the takeover offer but in the end the company does it because the directors believed it to be proper. Darvin v North Sydney Brick and Tile

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Create/destroy voting power of majority shareholders

* Use of company funds to promote reelection of directors: Expenditure should be kept to a minimum and be confined to providing information that promotes an informed decision by shareholders Advance Bank Australia v FAI Insurances

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Doesn't matter if the director didn't actually benefit in the end Adler

Duty to retain discretions: (fiduciary duty)

1. Directors must give (1) matters adequate and active consideration to each exercise of his power and (2) not fetter his discretion, following from the fiduciary relationship between D and the company Thornby

2. Directors shouldn't bind themselves to agree to act because if company's circumstances change, they should be free to act

3. If the director is just used to doing whatever they are told, they are in breach of their duty.

Duty to avoid actual and potential conflicts of interest

d. Fundamental rule: There is a 'fundamental rule of equity that a person in a fiduciary capacity must not make a profit out of his trust which is part of the wider rule that a trustee must not place himself in a position where his duty and his interest may conflict'. Phipps v Boardman

i. If a fact situation doesn't fall within the cases you have looked at, you come back to the fundamental rule: do their interests conflict with the interests of the company ii. If you have a breach of this rule, you probably have a breach of acting in best interests and good faith e. No Conflicts Rule: Fiduciary must account to the beneficiary 'for any benefit or gain received by the fiduciary in circumstances where there existed a conflict of personal interest and fiduciary duty or significant possibility of such conflict: the objective is to preclude the fiduciary from being swayed by considerations of personal interest'. i. Fiduciary

* Overlaps with good faith and best interests of the company

* Directors must not place themselves in a position where there is 'a real sensible possibility of conflict' between their personal interests and their duty to act in the best interests of the company unless the permission of the company is obtained Phipps v Boardman (1967)

* A conflict per se is not fatal. What is important is that you don't take advantage of it and make full disclosure and get permission. Intention is irrelevant

* The fiduciary's duty may be more accurately expressed by saying he is under an obligation not to promote his personal interests by making or pursuing a gain in circumstances in which there is a conflict or a real or substantial possibility of a conflict between his personal interest and those of the persons whom he is bound to protect. Hospital Products Ltd v United States Surgical Corp

* NB: o Does not arise where a mere unenforceable expectation, must have a personal interests of a contractual nature Baker v Palm o Must be a personal interest o A CC may modify the strict fiduciary requirement to disclose to shareholder by merely insisting on disclosure to the other directors Woolworths Ltd v Kelly

* Minimum requirements for nonbreach: o The steps D must take not to breach his duty depend on the facts, but the min requirement is disclosure of interests and nonparticipation. Look at: i. Subject matter, states of knowledge of the adverse information, degree to which D has been involved in the transaction, whether D has been promoting the cause and gravity of possible outcomes

* Situations where this conflict may arise: o Directors contracting with the company: i. Voidable at the option of the company unless:

1. Contract disclosed to and approved by company (members in a general meeting)

2. Permitted by the constitution (e.g. nominee directors - Levin v Clark) o Director of a competing company i. Because the company is entitled to independent and unbiased judgment of D, as D is director of company A and company B, he must not exercise powers for the benefit of (company 1 or company 2) without Clearly disclosing to the other company his interest in (first company) and obtain other company's fully informed consent Byrnes ii. No breach provided Bell

1. No confidential information divulged

2. It is not contrary to company's constitution

3. It is not contrary to any express or implied agreement (likely to be contrary to an executive director's employment contract) iii. On the street Pty ltd v Cott o Director of companies on opposite sides of a contract

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