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Class 10: Directors’ duty of care
Understand how the director’s duty of care fits into the broader scheme of director’s duties.
Know the different sources of the director’s duty of care and the main consequences of those differences.
Know in outline the main cases that inform the interpretation of s180(1).
180(1) is duty of care and diligence.
181 is the duty to act in good faith and for a proper purpose. Don’t forget general law contract, company law, tort and equity (fiduciary power and doctrine of powers).
Sections 182 and 183 are duty to avoid conflicts and secret profits.
Corporations Act s 180, 189-190, 198D.
CORPORATIONS ACT 2001 - SECT 180 The statutory duty of care
Care and diligence--civil obligation only
Care and diligence--directors and other officers
Duty of care and diligence.
Business judgment rule
(2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection(1), and their equivalent duties at common law and in equity, in respect of the judgment if they:
(a) make the judgment in good faith for a proper purpose; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
Note: This subsection only operates in relation to duties under this section and their equivalent duties at common law or in equity (including the duty of care that arises under the common law principles governing liability for negligence)--it does not operate in relation to duties under any other provision of this Act or under any other laws.
(3) In this section:
Makes it clear that the standard of care and diligence is determined both by reference to the company’s circumstances and the director or officer’s position and responsibilities within the company.
The scope of the statutory duty and its relation to the general law are examined in ASIC v Adler and ASIC v Rich.
The statutory duty of care remains a civil penalty provision.
CORPORATIONS ACT 2001 - SECT 189
Reliance on information or advice provided by others
(b) the reliance was made:
(i) in good faith; and
(ii) after making an independent assessment of the information or advice, having regard to the director's knowledge of the corporation and the complexity of the structure and operations of the corporation; and
(c) the reasonableness of the director's reliance on the information or advice arises in proceedings brought to determine whether a director has performed a duty under this Part or an equivalent general law duty;
CORPORATIONS ACT 2001 - SECT 190
Responsibility for actions of delegate
(2) A director is not responsible under subsection(1) if:
(a) the director believed on reasonable grounds at all times that the delegate would exercise the power in conformity with the duties imposed on directors of the company by this Act and the company's constitution (if any); and
(b) the director believed:
(i) on reasonable grounds; and
(ii) in good faith; and
(iii) after making proper inquiry if the circumstances indicated the need for inquiry;
that the delegate was reliable and competent in relation to the power delegated.
CORPORATIONS ACT 2001 - SECT 198D
(a) a committee of directors; or
(b) a director; or
(c) an employee of the company; or
(d) any other person.
(2) The delegate must exercise the powers delegated in accordance with any directions of the directors.
(3) The exercise of the power by the delegate is as effective as if the directors had exercised it.
What is a fiduciary?
Facts based vs status based fiduciaries (Hospital Products Ltd v US Surgical Corp (1984)). Key case.
The Fiduciary obligations (Breen v Williams (1996))
Proscriptive not prescriptive.
Conflicts rule. You must not put yourself in a position where your duty to another conflicts with your duty in the fiduciary relationship.
Secret profits rule. You can’t abstract financial profit from something not contemplated in the nature of the relationship.
The director as fiduciary. A director is not a trustee- Sealy and Romer J in re City Equitable. There are substantial differences between trustees and fiduciaries.
The existence of a duty of care for directors:
Imposed by statute- s180(1).
Imposed by equity- but not a fiduciary one. Permanent Building Society v Wheeler.
Express or implied in a special contract. Lister v Romford Ice and Cold Storage.
Established on something approximating the ‘neighbour’ principle familiar to tort- Permanent Building Society v Wheeler.
They are distinct grounds- there may be divergent consequences. Permanent Building Society.
The statutory duties:
Section 180- duty of care and diligence. The degree of care and diligence that a reasonable person would exercise.
S189- reliance on information/advice of others. Under what circumstances can a director rely on other people.
S190- responsibility of delegates’ acts.
180(2)- the business judgement rule. New provision. Where the director acts bona fide and takes a risk then they won’t be held liable for a loss from that. Their role is not trustee of the assets but to make commercial judgements.
By whom are the duties owed?
At general law: directors and senior executive officers.
Under the Corps Act
Director includes under s9
b)(i) de facto directors
b)(ii) shadow directors. Standard chartered v Antico. They are working like a director and others act upon his instructions as if they were a director. They are often a puppet master and not overt.
Officer also defined broadly under s9.
ASIC v Macdonald. General council and CFO are found to be covered by the officer.
Re HIH; ASIC v Adler.
|The Key Players|
|Ray Williams||Dominc Fodera (CFO of HIH)||Rodney and Lyndi Adler (directors)|
|HIHC||AEUT (Unit trust)|
The company is owed the duty
The requisite standard of care.
Under special contract- as per term in contract.
The old cases
Re Denham and Co- country gent, not accountant.
Re Cardiff savings bank- Marquis of Bute
Re Brazillian Rubber plantations- rubber baron.
Re City Equitable:
Duties and standard depend on circumstances.
Actually a subjective test- what knowledge/experience did director have?
Not continuous attention but intermittent
Director entitled to trust delegate unless ground for suspicion.
The remedy for breach of the general law duty of care and diligence and its statutory complements is the award of damages to compensate the company for loss caused by the breach. Both the general law and statutory duties are owed by individual directors and officers who are personally liable for breach of duty.
For a solvent company seeking compensation from current or former officers for loss caused by neglect of duty, the primary remedies will be those arising under a service contract or for breach of the general law duty of care.
The general law duty of care
At general law directors owe a duty to their company to take reasonable care in performing the functions of office.
The standard of care is measure by the care that an ordinary man might be expected to take in the circumstances made upon his own behalf.
The general standard of care was that which can “reasonably to be expected of (each director) having regard to his knowledge and experience…[not] by considering what the court itself would think reasonable – Re Brazilian Rubber Plantations and Estates Ltd 
The appeal decision in Daniels v Anderson (1995) marked a significant point of change in the legal development of the standard of care.
In 2000, directors were given the benefit of statutory presumption of reasonableness where they rely upon information or advice provided by an employee, other officer, personal adviser or expert whom the director reasonably believes to be reliable and competent, however reliance must be made in good faith and be based upon the director’s independent assessment of the information or advice; s 189.
Note: This protection is limited to proceedings brought to determine whether a director has performed the statutory or general law duty of care; s 189(c).
Directors were relieved of responsibility for the acts of those whom they have delegated powers where the director believes on reasonable grounds that:
The delegate would exercise the power in conformity with the director’s duties and the company’s constitution and
In good faith, and after making proper inquiry if the circumstances indicated the need for inquiry, the delegate was reliable and competent in relation to the power delegated s 190(2).
The Statutory Duty of Care
The Act provides that a director or officer must exercise the degree of care and diligence that a reasonable person would exercise if they were a director or officer of a company in the company’s circumstances and occupied the office held by, and had the same responsibilities within the company as, the director or officer – s180(1).
Although there is no requirement in s180(1) for harm or detriment to the company, the same balancing of foreseeable risk and benefit applies as under general law duty.
Court of Appeal of the Supreme Court of New South Wales
AWA manufactured electronic and electrical products.
Hooke was the MD.
The company decided to hedge against currency fluctuations by engaging in forward purchases of foreign currency against contracts for imported goods. Koval was employed, because the Board did not understand the transactions, to manage the foreign exchange operations. The oversight of the company’s FX operations was left to its general manager and finance manager who were inexperienced with FX transactions.
Koval’s dealings caused the company to incur considerable losses. Koval managed to conceal the fact of these losses.
During the period of Koval’s employment, the company’s auditor, DHS, conducted two audits. In neither audit was Koval’s activities fully disclosed to the AWA Board, although the auditor had noted the defects in the company’s system of internal controls.
AWA’s failure to establish adequate internal controls and record and account keeping had allowed the losses to be concealed.
AWA sued the auditor for negligence for failing to draw attention to these deficiencies and to qualify the audit reports. The auditor denied any breach of duty to AWA and cross-claimed against it an, inter alia, the non-executive directors for contributory negligence. The efficacy of this cross-claim depended upon establishing that the directors owed a duty of care in tort to their company.
Illustrates importance of choosing grounds carefully, in this case seeking tortious liability.
Possibility of distinguishing between standards expected of executive and non executive directors.
Koval made losses for AWA and concealed them (like Gleeson case). He was a good currency trader but then it went really badly.
They said the directors knew this was going on. The court found that the non executive directors did not breach their duties but they found the chairman Hook did break his duty due to his awareness of what was going on. Auditor pay 2/3 and company pay 1/3 of loss. Duty to supervise and monitor.
Clarke and Sheller JA: The US decision, in Francis v United Jersey Bank, articulated what the law requires of directors in Australia
“A director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly a director should become familiar with the fundamentals of the business in which the corporation is engaged…Directors are under a continuing obligation to keep informed about the activities of the corporation... Directorial management does not require a detailed inspection of day-today activities, but rather a general monitoring of corporate affairs and policies...While directors are not required to audit corporate books, they should maintain familiarity with the financial status of the corporation by a regular review of the financial statements… The review of financial statements, however, may give rise to a duty to inquire further into matters revealed by those statements”
The director owes to the company a duty to take reasonable care in the performance of the office.
A person who accepts the office of director of a particular company undertakes the responsibility of ensuring that he or she understands the nature of the duty a director is called upon to perform. That duty will vary according to the size and business of the particular company and the experience or skills that the director held himself or herself out to have in support of appointment to the office. Breach of that duty will found an action for negligence at the suit of the company.
DHS’ cross claims for indemnity or contribution depended upon establishing that Hooke and the NED were tortfeasors “liable in respect of the same damage: suffered by AWA as that for which DHS were also liable
It was not unreasonable for the non-executive directors to have accepted the assurance they received from the DHS as to the genuineness of the reported profits and from senior management as to the state of compliance with FX policy.
The position with respect to Hooke was different since he had received information from reliable sources, including DHS, which he had not communicated to the board, which pointed to serious deficiencies in internal controls.
DHS owed a duty to report the absence of proper records sand internal control to management and then in the absence of timely and appropriate action, to the board.
The court apportioned the damages to be borne as to one third by AWA and as to two thirds by DHS.
What to get from this case – a partly objective standard. Director does have to understand at a basic level and pay attention to the company, but it still depends on the office the director holds on how they actually have to do to discharge that duty.
Did the COA require skill? Yes. Because you cannot monitor, supervise, understand or have insights if you do not have basic skills. Although section 180 doesn’t require skills the general law on directors always has.
Supreme Court of Western Australia
This case involved a building society director, Hamilton, who was also on the board of a potential borrower JCLD. He knew, but others within the society did not, that the potential borrower was in financial difficulties.
He declared his interest as MD of JCLD and took no part in the decision or voting.
The director stood silently by and allowed the society to make the relevant loan.
|VH||Permanent building Society|
Conflict of interest case more than a duty of care case.
Raises the distinction between tortious, equitable and fiduciary duties. Matters because of causation and remedies. However the content (i.e. the standards required are the same).
Conflicted abstention does not relieve directors of duty of care.
Hamilton was one of the only directors not involved in this. He was CEO and MD of Permanent building society. He excused himself from voting but the court held that because of the lack of experience they had and the lack of organisational business, they should have scrutinised the proposal even more closely. Hamilton owed this duty of care even though he excused him self for conflict of interest. Usually the view is you should exclude yourself. The court said you still have a duty of care even though you side stepped the duty.
Justice Ipp said there is a distinction in the sources of rules. He said the duty of care was not fiduciary. But there is a stricter duty of causation under common law. It’s a but for test in equity and there are differences in remedies. He said it is not fiduciary but it is still recognised in equity. You still have causation rules and the equitable remedies.
Duty to exercise reasonable care and skill
The test is what an ordinary person, with the knowledge and experience of the defendant, might be expected to have done in the circumstances if he was acting on his own behalf.
In the circumstances, there was a heavy duty on the respondents and Hamilton to scrutinise the proposed transaction with caution and thoroughness.
That duty was not affected by the fact that Hamilton believed that he had a conflict of interest and accordingly did not vote when the resolutions in question were taken. It was manifest that the transaction was capable of causing PBS serious harm.
Hamilton could not avoid his duties as CEO and MD by asserting his perceived interest of conflict.
As CEO and MD there was a responsibility on him to ensure that the other directors appreciated the potential harm inherent in the transaction and to point out steps that could be taken to reduce the possibility of that harm.
Hamilton therefore breached his duty to exercise skill and care as a director of PBS.
The casual connection between breach and loss
It still must be proved that the breach of duty caused loss to PBS.
The question of causation arises in the context of the attribution of fault or responsibility whether an identified negligent act or omission of the defendant was so connected with the plaintiff’s loss or injury, that as a matter of ordinary common sense and experience, it should be regarded as a cause of it.
For PBS to prove that Hamilton’s breach of duty caused loss to PBS, PBS is required to establish that had a reasonable director in Hamilton’s position exercised reasonable care and skill, he or she would have expressed opposition to PBS entering into the Sale Agreement.
Apply test in Vrisakis v Australian Securities Commission (1993)
The test is basically an objective one in the sense that the question is what an ordinary person, with the knowledge and experience of the defendant might be expected to have done in the circumstances if he was acting on his own behalf.
The case was about Rockwells. He decided to participate in a corporate restructure.
ASIC v Maxwell (2006) was the question was did the other directors have a duty to stop Maxwell?
Vines v ASIC- can certain GIO senior executives have breached their duty by not advising about the impacts of hurricane George for the insurance company. They had calculations but failed to disclose them to the purchasers.
ASIC v Mac Donald and on appeal Morley v ASIC. Directors did not disclose enough to ASX. What responsibility did the individual directors have in making a misleading disclosure- where they a party to it?
ASIC v Rich. Failure of One Tel where packer and Murdoch lost one billion dollars between them. There was a question that directors did not provide information to shareholders.
The duty arises across 4 different strands and may be differences in the causality if there is a multi valent duty. Requirement for harm or detriment for plaintiff to succeed. Wheeler and Sheahan v Verco (2001). Not in s180.
Defences: Laches (delay in coming to court), clean hands in equity, business judgement rule (s180(2)).
Remediation is under CA, contributory negligence (Daniels v Anderson), restitution is not the same as common law damages (Re Dawson (1966))
Grumpy can establish a s180(1) contravention of the duty or care (high interest rate and Ben has a conflict of interest and there is a covenant that is very tough requiring Elle to help make decisions and Rip was not aware of the decision and he should not have been asleep) and Grumpy can convene a GM and have them oust the BOD.
Bill, Ben and Rip will use the business judgement rule under s180(2). They must be acting in good faith and for proper purpose but Ben might not be able to establish because the loan is from his wife and he has a material personal interest and he is an accountant so he should have a higher standard. Bill may have not informed himself properly- he is not knowledgeable about whether it is a good loan. Rip keeps falling asleep but he is a non executive director but this wont help him sleeping through meetings. S180(2) is a defence to 180(1).
S198 reserves this decision to the board. It is a management decision.
Information not reasonably reliable under s189.
Rip was asleep. Did he need to vote? But he was non executive officer. He should be awake and he should resign if he cannot fulfil the role. Shareholders problem and they need to get rid of the director.
S180(2) business judgement rule. Was this rational decision and bona fide? Conflict of interest. He gave a large loan to his wife. He should have disclosed his conflict of interest (Ben).
No care and diligence of a reasonable person under s180(1).
Also consider statement made by Rogers CJ in AWA Ltd v Daiels (1992):
The directors rely on management to manage the corporation. The board does not expect to be informed of the details of how the corporation is managed. They would expect to be informed of anything untoward or anything appropriate for consideration by the board.
In light of the financial circumstances of the case, it cannot be said that a reasonable director of PBS , knowing of the true position of Tower and covenantors, would have expressed opposition to and voted against the Sale Agreement.
Thus PBS has failed to establish on the balance of probabilities that loss was caused by a breach of Hamilton’s duty of care owed to PBS at common law.
Causality and the breach of the equitable duty of care
The tortious duty not to be negligent and the equitable obligation on the part of a trustee to exercise reasonable care and skill are the same.
Thus PBS failed to prove that but for the breach by Hamilton of his equitable duty to exercise reasonable care, the loss to PBS would not have occurred – due to reasons above.
Supreme Court of NSW
Adler was a director of HIH. Adler caused HIHC, a subsidiary of HIH, to make an unsecured loan of $10 million to a company, PEE, which he controlled as trustee for HIH.
The loan was made with the knowledge of Williams, the CEO of HIH, and Fodera, the CFO.
The loan funds were applied:
To purchase HIH shares – made ostensibly by Adler with his personal funds with the purpose of signalling his confidence in the company and thereby stabilising its falling share price.
To purchase technology stocks held by Adler
Used as unsecured loans to companies associated with Adler.
HIH went into liquidation.
ASIC commenced civil proceedings against Adler, Williams and Fodera for contravention of several civil penalty provisions including s 180(1).
The judge found that Adler was a “officer” of HIHC since he was a member of its investment committee.
Directors owe a duty of care and skill at common law and in equity: Permanent Building Society (in liq) v Wheeler (1994) 14ACSR 109; Daniels t/as Deloitte Haskins & Sells v AWA Ltd (1995) 37NSWLR 438.
However, the equitable duty to exercise reasonable care and skill is not properly classified as a fiduciary duty: Permanent Building Society (in liq) (supra) per IppJ.
The statutory duty of care and diligence, s180, is framed in similar terms to its predecessor s232(4). It has been said of the latter that the duties imposed upon directors by it are essentially the same as the duties of directors under the common law:
In determining whether a director has exercised reasonable care and diligence one must ask what an ordinary person, with the knowledge and experience of the Defendant might be expected to have done in the circumstances if he or she was acting on their own behalf: Permanent Building Society v Wheeler .
However, under the implied term in a contract of employment of an executive director, the director (such as here MrWilliams and MrFodera) will be taken to have promised the company that he or she has the skills of a reasonably competent person in his or her category of appointment and that he or she will act with reasonable care, diligence and skill: Permanent Building Society v Wheeler at 287-8.
Although the standard of reasonable care is generally said to be that of an ordinary prudent person (Re City Equitable Fire Insurance Co. Ltd ) there is some suggestion that directors of a professional trustee company owe a higher duty of care: Wilkinson v Feldworth Financial Services Pty Ltd (1998) .
In determining whether a director has breached the statutory standard of care and diligence (s180(1)), the court will have regard to the company’s circumstances and the director’s position and responsibilities within the company: see also Explanatory Memorandum to the CLERP Bill 1999 (para6.75).
In accordance with these responsibilities directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company: Daniels t/as Deloitte (supra) at664. That is to say, (supra) at 666-67:
a director should become familiar with the fundamentals of the business in which the corporation is engaged;
a director is under a continuing obligation to keep informed about the activities of the corporation;
directorial management requires a general monitoring of corporate affairs and policies, by way of regular attendance at board meetings; and
a director should maintain familiarity with the financial status of the corporation by a regular review of financial statements. Indeed, he or she will be unable to avoid liability for insolvent trading by claiming that they had never learned to read financial statements: Commonwealth Bank of Australia v Friedrich (1991) 5ACSR 115 at 125.
A director appointed to a company because of special expertise in an area of the company’s business is not relieved of the duty to pay attention to the company’s affairs which might reasonably be expected to attract inquiry, even outside that area of expertise: Re Property Force Consultants Pty Ltd (1995) 13ACLC 1051 at 1061.
At general law, a director is entitled to rely without verification on the judgment, information and advice of management and other officers appropriately so entrusted. However, reliance would be unreasonable where directors know, or by the exercise of ordinary care should have known, any facts that would deny reliance on others: Daniels t/as Deloitte at 665-6.
Although reasonableness of the reliance or delegation must be determined in each case, the following may be important in determining reasonableness:
the function that has been delegated is such that “it may properly be left to such officers”: Re City Equitable Fire Insurance Co Ltd (supra) per RomerJ .
the extent to which the director is put on inquiry, or given the facts of a case, should have been put on inquiry: Re Property Force Consultants Pty Ltd (supra) per DerringtonJ at 1,060.
the relationship between the director and delegate, must be such that the director honestly holds the belief that the delegate is trustworthy, competent and someone on who reliance can be placed. Knowledge that the delegate is dishonest or incompetent will make reliance unreasonable: Biala Pty Ltd v Mallina Holdings Ltd (1994) 15ACSR 1 at 62.
the risk involved in the transaction and the nature of the transaction: Permanent Building Society v Wheeler (1994) 14ACSR 109 (although in this case the Chief Executive Officer in question also had a conflict of interest).
the extent of steps taken by the director, for example, inquiries made or other circumstances engendering “trust”;
whether the position of the director is executive or non-executive: Permanent Building Society v Wheeler per IppJ, though, in Daniels v Anderson (supra), the majority have moved away from this distinction.
That general law explains what the Corporations Act now requires when referring (s190(2)) to “reasonable grounds” in codifying the directors’ responsibilities for the actions of the delegate. Thus under s198D of the Corporations Act directors may delegate any of their powers to a committee of directors, a single director, an employee of the company or any other person (This delegation must be recorded in the company's minute book: see s251A). Moreover, the director will be responsible for the delegate’s exercise of power if he or she did not believe on reasonable grounds and in good faith, after making proper inquiries if the circumstances indicate the need for it, that the delegate was reliable and competent in relation to the power delegated and would exercise the power in conformity with the duties imposed on the directors of the company by the Corporations Act: s190(2).
For the purposes of s180(1) and relevantly in the present case, failing to ensure that a company makes loans only in accordance with its authorised practices and failing to ensure that the company has a proper system of controls and audit in its business to avoid any defalcation by officers and employees may amount to breaches of the statutory duty of care and diligence: Cashflow Finance Pty Ltd v Westpac Banking Corp .
Where there is a transaction involving the potential for conflict between interest and duty, as here arose, the duty of care and diligence falls to be exercised in a context requiring special vigilance, calling for scrupulous concern on the part of those officers who become aware of that transaction to ensure that any necessary corporate approvals are obtained and safeguards put in place. While the primary responsibility will fall on the director or officer proposing to enter into the transaction, this does not excuse other directors or officers who become aware of the transaction.
The business judgement provisions of section 180(2) could not apply to Mr Adler. There was no business judgment shown by Mr Adler to have been made in good faith for a proper purpose under s180(2)(b). There was no evidence that he ever turned his mind to a judgement of what safeguards there should be.
Williams did not make any judgement in good faith and for a proper purpose under s180(2)(a).
There is no basis that Williams properly informed himself about the subject matter of any judgment he made like having proper independent advice obtained under s180(2)(c).
There was no rational belief under s180(2)(d) that Williams should have confidence in Adler’s abilities because all the initial gains from One Tel had been wiped out.
The statutory Business judgement rule
In order for the safe-harbour “statutory business judgment rule” to be relied upon, the director must first have made a business judgment. Then that business judgment must satisfy the following requirements,
namely made in good faith for a proper purpose;
after the director has informed himself as to the subject matter of the judgment to the extent he reasonably believes to be appropriate;
in circumstances where the director does not have a material personal interest in the subject matter of the judgment
and rationally believes that the judgment is in the best interests of the corporation: s180(2).
The director’s belief that his or her judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in that position would hold: s180(2).
A business judgement is defined as any decision to take...
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