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Directors’ Duty Of Care Notes

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This is an extract of our Directors’ Duty Of Care document, which we sell as part of our Business Associations I Notes collection written by the top tier of University Of New South Wales students.

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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. (1) A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they: (a) were a director or officer of a corporation in the corporation's circumstances; and (b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer. Note: This subsection is a civil penalty provision (see section 1317E).

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 (b) do not have a material personal interest in the subject matter of the judgment; and (c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and (d) rationally believe that the judgment is in the best interests of the corporation. The director's or officer's belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold. 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: "business judgment" means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

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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 If: (a) a director relies on information, or professional or expert advice, given or prepared by: (i) an employee of the corporation whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned; or (ii) a professional adviser or expert in relation to matters that the director believes on reasonable grounds to be within the person's professional or expert competence; or (iii) another director or officer in relation to matters within the director's or officer's authority; or (iv) a committee of directors on which the director did not serve in relation to matters within the committee's authority; and (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; the director's reliance on the information or advice is taken to be reasonable unless the contrary is proved. CORPORATIONS ACT 2001 - SECT 190 Responsibility for actions of delegate (1) If the directors delegate a power under section 198D, a director is responsible for the exercise of the power by the delegate as if the power had been exercised by the directors themselves. (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 Delegation (1) Unless the company's constitution provides otherwise, the directors of a company may delegate any of their powers to: (a) a committee of directors; or (b) a director; or (c) an employee of the company; or (d) any other person. Note: The delegation must be recorded in the company's minute book (see section 251A). (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)) o 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: o Imposed by statute- s180(1). o Imposed by equity- but not a fiduciary one. Permanent Building Society v Wheeler. o Express or implied in a special contract. Lister v Romford Ice and Cold Storage. o Established on something approximating the 'neighbour' principle familiar to tort- Permanent Building Society v Wheeler. o They are distinct grounds- there may be divergent consequences. Permanent Building Society.

* The statutory duties: o Section 180- duty of care and diligence. The degree of care and diligence that a reasonable person would exercise. o S189- reliance on information/advice of others. Under what circumstances can a director rely on other people. o S190- responsibility of delegates' acts. o 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.

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By whom are the duties owed?
o At general law: directors and senior executive officers. o 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 Rodney and Lyndi (CFO of HIH) Adler (directors) Directors

Investment committee

HIH

director PEE (Trustee)

Adler Corp

Directors HIHC

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AEUT (Unit trust) The company is owed the duty The requisite standard of care. o Under special contract- as per term in contract. o The old cases
? Re Denham and Co- country gent, not accountant.
? Re Cardiff savings bank- Marquis of Bute
? Re Brazillian Rubber plantations- rubber baron. o 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.

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Redmond [7.70]-[7.130]. An Overview of Duties and Remedies

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Three species of legal rule are directed primarily towards the problem of shirking and underperformance:

1. The general law imposes upon directors and senior officers a duty to their company to apply reasonable care in the performance of their office. The duty of care arises in equity and tort (so directors may be liable in liquidated damages for breach of duty). The duty is NOT fiduciary

2. The general law is complemented by a statutory duty of care and diligence contained in s180(1). The Act provides a safe haven from liability for breach of the duty of care in respect of business judgments if certain conditions are met under s180(2), and defines the circumstances in which directors and officers may rely upon information or advice provided by others - s189.

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The Act imposes a specific obligation upon directors to prevent their company from incurring debts while it is insolvent and imposes personal liabilities upon directors subject to defences.

* 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.

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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 [1911]
The appeal decision in Daniels v Anderson (1995) marked a significant point of change in the legal development of the standard of care. Statutory responses o 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. o 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). o 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

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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.
[7.85] Daniels v Anderson (1995) 37 NSWLR 438

* Court of Appeal of the Supreme Court of New South Wales Facts:

* 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.

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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.

Held:

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Clarke and Sheller JA: The US decision, in Francis v United Jersey Bank, articulated what the law requires of directors in Australia o "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. Present case

* 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.

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The court apportioned the damages to be borne as to one third by AWA and as to two thirds by DHS.

Ratio:

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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.
[7.90] Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187

* Supreme Court of Western Australia Facts:

* 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. Wheeler Tower VH

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JCLD

CHL Director 2/3 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.

Held:

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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. Present case:

* 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.

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