#10832 - Directors’ Duty To Act In Good Faith And For Proper Purposes - Business Associations 1

[7.125] An overview of remedies and their outcomes

• Redmond draws attention to two elements of the fiduciary duty imposed upon directors – the duty of good faith (which has several separate elements) and the fiduciary obligation to avoid situations of a conflict of interest without the company’s consent

• He distinguishes the duty of good faith from other general law doctrines on two bases:

  • The duty applies to directors making decisions or exercising powers for the corporation, or performing functions as individuals delegated to them by the board – but they are exercising corporate powers acting in a corporate role

  • The duty of good faith permits a challenge to be made of a particular decision taken or transaction entered into – with remedies including orders setting it aside (in appropriate case)

    • That is, personal liability isn’t the only possible consequence – it targets the decisions themselves.

    • The right of the company to set aside the transaction depends on proof that the other party to the transaction did or did not have notice of the breach (Harlowe’s v Woodside) – once breach and notice are established, this displaces the assumption that company officers properly perform their duty (s 129(4)) through knowledge or suspicion that it is indeed incorrect that they do (s 128(4))

• This is in contrast to the duties with respect to derivation of profits from their office or transaction – in these circumstances remedies for breach are concerned with personal liability rather than the particular decision

  • Thus the remedies sounding will be for equitable compensation to account for profits or liability as a constructive trustee of property acquired in circumstances sufficiently connected with the corporate office as to offend the equitable rule enjoining conflicting avoidance by fiduciaries

[7.220] Judicial reluctance to intervene in directors’ decisions

• Redmond quotes from justices who intimate that courts do not intervene into the policy decisions, or assess the merits of business decisions – reflecting the limited institutional expertise of the courts

• But despite this the duties of good faith fashioned by the equitable jurisdiction of the courts have created a tool for limited judicial control of the exercise of directors’ powers and management decisions

  • This has inexorably led to intervention into board decision and substitution of judicial views for that of directors, at least in the most egregious of cases

[7.225] The elements of the duty to act in good faith

• The duty was traditionally expressed as requiring directors to act bona fide for the benefit fo the company as a whole (same as for shareholder voting power) – however it differs due to the fiduciary nature of the duty

• Redmond comments that the duty is not readily divisible into its discrete elements of a subjective duty of good faith and an objective benefit into the company – it is directed at the intention, motive and beliefs of the directors and whether they made the interests of the company their principal consideration

  • Thus if the power is exercised for themselves (as in Gilbert’s Case) or to confer a benefit on a third party or class of shareholders (Kerry v Moon Dream Gold Mines) or damage the company itself – the duty will have been breached

• Redmond comments that the modern duty of faith contains three distinct elements which are independent but interrelated duties – all applicable to a directors exercise of corporate power. Each of them are a self-contained means to judicial review into directors decision.

[7.230] The duty of subjective good faith

• This is a duty to act honestly in the company’s interests as the directors perceive them – a duty of honesty/ subjective good faith.

  • Though good faith is determined objectively, the inquiry is confined to the director’s subjective intent.

  • An honest belief that action is in the company’s interest, though, a necessary not sufficient condition of the validity of a decision – the other two elements of the duty may vitiate it

[7.235] The duty to exercise powers for a proper purpose

• This element is a duty on directors to exercise corporate powers only for the purpose which they were granted to directors – it permits courts to invalidate decisions taken by directors if their motivating purpose is one which a court determines is beyond those which the power can be legitimately exercised

• Though some powers have specific limitations, others may be general and can’t be defined otherwise than having a “corporate purpose” or a director’s intention to benefit of the company

• The origin of the doctrine of equitable fraud in the proper purpose doctrine stems from the equitable doctrine relating to fraud on the powers of appointment given by one to another with respect to disposition of their properties

• Redmond notes that the distinction between this and the above duty is not so easily drawn and sometimes conflated (like in Ngurli v McCann) – sometimes the need to treat them separately won’t be necessary since decisions can be characterised equally as lacking subjective good faith or motivated by an improper purpose

  • This is so especially where the purpose characterisation of the corporate power in question is solely in terms of an intent to benefit the company

  • Thus where the power is capable of being characterised objectively the distinction between these two requirements becomes important

• Redmond notes that because the strict fiduciary duties do not sit comfortably with the realities of a directors’ office (like in proprietary companies where directors are also shareholders) – mixed purpose doctrines have been developed. In Mills v Mills

  • Latham CJ noted that invalidating actions just because of an interest would set an impossible standard and require directors to live in an unreal region of detached altruism and thus posed a moving cause test

  • Dixon J noted the reality of many purposes animating human conduct and in this context said that this can’t be applied to resolutions a body of directors and thus the general equitable principle doesn’t sit well with directors managing a company as compared to trustees exercising a power of appointment

    • Thus Dixon J posted a test of the substantial object of the accomplishment of which formed the real ground of the board’s action that had to be within the scope of the power – an ulterior purpose will mean the ostensible exercise of the power is void

• A number of the modern decisions on proper purpose are about the question of whether the directors’ exercise of power can be exercised within scope to manipulate takeovers – but due to the introduction of the Takeovers panel, this has largely been subsumed

[7.240] The duty to consult and act by reference to company interests

• The last element is the duty to consult and act by reference to those interests which the law identifies as that of the company, and have regard to outside interests only derivatively – this element isn’t tied to the director’s subjective due faith and denies the role of directors as definitive interpreters of the company’s interests. Bona fide’s alone leaves open the possibility of having a “lunatic conducting the affairs of the company” (Hutton v West Cork Railway – Bowen LJ)

  • Thus where directors act by reference to interests extraneous to those recognized by the law as being that of the company – the actions will not be saved by an honest believe that they act for the company’s benefit

• As such, the three elements of the duty mark out the realms of conduct that will sustain judicial intervention into directors’ decision

• [7.245] The individual subjects of the duty – though the duty attaches to the exercise of powers vested in the board acting collectively – the duty is owed by directors individually

  • The question as to whether the duty has been breached, and thus the validity of a directors’ decision, is tested by inquiry as to each individual directors’ intention and purpose – the validity of the directors’ decision is determined by reference to the motive and purposes animating the majority of the board

  • Thus if the corporate power is vested in an individual – e.g. by the constitution in a governing director (as in Whitehouse v Carlton Hotel) or by delegation to an MD, the purpose and intention is that of the individual director

  • In their formal expression in most cases the duties apply to directors without corresponding reference to other corporate officers, reflecting the doctrine prior to modern separation fo director/management roles

    • But the doctrines apply equally to actions taken by other senior corporate powers exercising powers delegated to them by directors or vested in them by the CC

[7.250] The statutory duty of good faith

• Co-extensive and complementary to the general law duty is the statutory duty contained in s 181(1) which provides that a director or other officer must exercise their powers and discharge their functions:

  • A) In good faith in the best interests of the company and;

  • B) for a proper purpose

• Persons involved in contraventions of s 181(1) contravene s 181(2) and both of these are CPPs.

• If a director is reckless or intentionally dishonest and fails to exercise their powers and discharge their functions in good faith in the best interests of the company and for a proper purpose – they commit a criminal offence under s 184

  • Marchesi v Barnes – ‘acting honestly’ means bona fide in the...