#7405 - Directors’ Duty To Act In Good Faith And For Proper Purposes - Business Associations I

Class 12 Directors’ duty to act in good faith and for proper purposes

Corporations Act ss 181, 184.

CORPORATIONS ACT 2001 - SECT 181

Good faith--civil obligations

Good faith--directors and other officers

(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; and

(b) for a proper purpose.

Note 1: This subsection is a civil penalty provision (see section1317E).

Note 2: Section187 deals with the situation of directors of wholly‑owned subsidiaries.

(2) A person who is involved in a contravention of subsection(1) contravenes this subsection.

Note 1: Section79 defines involved .

Note 2: This subsection is a civil penalty provision (see section1317E).

CORPORATIONS ACT 2001 - SECT 184

Good faith, use of position and use of information--criminal offences

Good faith--directors and other officers

(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; or

(d) for a proper purpose.

Note: Section187 deals with the situation of directors of wholly‑owned subsidiaries.

Use of position--directors, other officers and employees

(2) A director, other officer or employee of a corporation commits an offence if they use their position dishonestly:

(a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or

(b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation.

Use of information--directors, other officers and employees

(3) A person who obtains information because they are, or have been, a director or other officer or employee of a corporation commits an offence if they use the information dishonestly:

(a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or

(b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation.

Redmond [7.215]-[7.305].

An overview of remedies and their outcomes

Fiduciary obligations:

• Duty of good faith – requires directors to exercise their powers not only in that manner required by law but also bona fide for the benefit of the company as a whole

• Duty to avoid situations involving a conflict of interest without the company’s consent

• The duty of good faith may be distinguished from other general law duties in two principal respects:

  • It applies to directors when they make decisions or exercise powers FOR the corporation

  • It permits a challenge to be made to a particular decision take of transaction entered into by directors, the remedies include orders to set aside the decision or transaction. This requires proof that the other party had knowledge of breach of duty. The assumption that directors properly perform duties s129, must be displaced by knowledge or suspicion that it is incorrect.

• This requires directors to act bona fide for the benefit of the company as a whole. Directors abuse their discretionary powers if they use them to achieve an advantage for themselves, a third party, a SH or class of SH’s, a stranger to the company, or to damages the company itself.

• The first obligation is a duty to act honestly in the company’s interests as the directors perceive those interests. Judicial review is confined to inquiry as to each director’s subjective intent.

• The second element is a duty upon directors to exercise corporate powers only for the purpose for which they were granted to directors. The court can invalidate decisions which go beyond the purpose or do not benefit the company generally. This is also taken to be ‘for the purpose for which it was conferred, not arbitrarily or at the absolute will of the directors, but honestly in the interest of the SH as a whole’.

• The third element is a duty to consult, and act by reference to, those interests which the law identifies as interests of the company, and to have regard to outside interests only derivatively. This is an objective test and creates a wider role for judicial intervention through review of directors’ decisions than under the subjective duty of good faith.

The individual subjects of the duty

• While the duty of good faith in each of its elements attaches to the exercise of powers vested collectively in directors as a board, the duty is owed by directors individually. Whether the duty has been breached and the consequent validity of the D’s decision is tested by inquiry as to each individual D’s intention and purpose.

• Should directors money be paid to people like employees? 8 lines down: Justice Bowen says ‘that is the general doctrine, bone fides cannot be the sole test. Just because you honestly believe something is not good enough. Otherwise you may have a lunatic perfectly bona fide yet perfectly irrational. The test must be what is reasonably incidental to and in the reasonable scope of carrying on the business of the company. Does it help the company get money (yes – tick). If not, is it reasonable to carrying on the business? Look at the facts. Is it done within the ordinary scope of the company’s business? What is required/necessary for the benefit of the company.

Facts:

• A company was formed to take over the business carried on by Smith and Fawcett. They were the only directors and shares were issued and divided equally. Article 10 of the company’s articles provided: “the directors may at any time in their absolute and uncontrolled discretion refuse to register any transfer of shares”. Fawcett died and executors applied to be members of the company. After smith appointed his solicitor as a director, they appealed again and applied to be registered as a member. They sought to have the company’s share register rectified.

Held:

• Lord Greene MR: Directors must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interest of the company, and not for any collateral purpose. The language of the article in the present case does not point out any particular matter as being the only matter to which the directors are to pay attention in deciding whether or not they will allow the transfer to be registered.

• There is nothing in my opinion, in principle or in authority to make it impossible to draft such a wide and comprehensive power to directors to refuse to transfer as to enable them to take into account any matter which they conceive to be in the interests of the company. The question is simple, whether on the true construction of the particular article the directors are limited by anything except their bona fide view as to the interests of the company.

• In the present case the article is drafted in the widest possible terms, and I decline to write into that clear language any limitation other than a limitation which is implicit by law, that a fiduciary power of this kind must be exercised bona fide in the interests of the company. Subject to that qualification, an article in this form appears to me to give the directors what it says, namely, an absolute and uncontrolled discretion.

• I am satisfied that there is no ground shown here for saying that the directors’ refusal had been due to anything but a bona fide consideration of the interests of the company as the directors see them.

Facts:

• There was a contest for control of an insurance company by 2 diff parties of SH. Mrs Ure acquired enough shares to have an ordinary resolution to get her husband onto the board. Article 21 conferred on the board a power to refuse to register share transfers without assigning a reason for its decision. They refused to register the transfers requested by Mr Ure. Mrs Ure commenced proceedings to have the company register the transfers and to restrain the holding of the proposed meeting and the proposed share issue.

Held:

• Isaacs J: Although the power involves discretion, it must be exercised as all such powers must be – bona fide for the purpose for which it was conferred, not arbitrarily or at the absolute will of the directors, but honestly in the interest of the SH as a whole.

• The majority has not the right to destroy or injure the common property or otherwise deprive the minority of their rights. Directors obtain their powers from the consensus of all the SH as expressed in the articles because the primary maxim of corporate action is the whole corporation. It follows that if the directors honestly acted upon the...