#8568 - Directors’ Duty To Act In Good Faith And For Proper Purposes To Print - Business Associations

BA 12 Directors’ Duty to Act in Good Faith and for Proper Purposes 1

Cases where breach 5

Examples of NO BREACH of duty: 6

Cases Good faith, best interests, proper purposes: Appendix 7

CB: Smith and Fawcett 7

CB: Ure 7

CB: Harlowe’s 7

CB: Hogg 9

CB: Ngurli McCann 9

CB: Ure 10

CB: teck 10

CB: Howard Smith v Ampol 11

CB: Whitehouse v Carlton 11

CB: Equiticorp 12

CB: ASIC v Adler 13

Section 79 provides that a person is involved in a contravention if, and only if, the person:

1. has aided, abetted, counselled or procured the contravention; or

1. has induced, whether by threats or promises or otherwise, the contravention; or

1. has been in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention; or

1. has conspired with others to effect the contravention.

Duty to act bona fide in best interests of the company for proper purposes (s 181): Checklist:

[Prelim: Note the facts: The constitution? Possible that company’s constitution could define intersts of company in a way that would affect directors’ duty: Whitehouse v Carlton ]

• Rule: Duty to act in good faith in best interests of co and for proper purposes (two rules, three elements): s 181 (civil penalty provision), s 184 (criminal offence where reckless or intentionally dishonest breach of s 181). (Re Smith; Harlowe’s Nominees; hogg v Cramphorn; Teck; Howard Smith v Ampol; Whitehouse; Equiticorp ; Adler; Bell Group)

  1. GL vs statute: same content of duty under general law as under statute BUT: (1) Statutory list is longer – ‘director or other officer’. Under general law, must be a fiduciary. (2) Proving breach of s 181 might be harder to prove on the brigishnshaw standard taking into account possible civil penalty consequences (Adler).

  2. the onus of showing that a power has not been properly exercised is on the party complaining: Ure

  3. Criminal offence: s 184 – if dishonest or reckless, when breaching s 181, you can be found to have criminal liability. Under Adler judges need proof of lack of honesty or intention to act improperly to be proven.

  4. Fiduciary duty, positive? On balance it is likely that this duty is fiduciary. However the HCA held in Breen that fiduciary duties are negative, and in Bell the court seemed to suggest that the s 181 duty and its general law equivalent could require action at times.

1. Does the duty apply? Director or other officer (s 181(1) or a person involved in a contravention (s 181(2)). Section 79 provides that a person is involved in a contravention if, and only if, the person.. eg aid/abets/counsels/induces/ was directly or indirectly knowingly concerned in or party to the contravention or has conspired with others to effect the contravention: s 79.

2. Three elements: (1) honest (2) interests of whole company (3) proper purposes

   1. First – honest. The test is subjective, court will be reluctant to infer mala fide: Smith and Fawcett . In Smith: director refused to register a transfer of shares to an ex directors’ son after the director died. constitution provided directors had absolute and uncontrolled discretion. No ground for concluding that refusal was subjectively bona fide.

   2. Second – in interests of whole company. (Where directors fail to consult or act by reference those the interests of the company they breach this duty (Greenhalgh; Ngurli; Parke). (Thus for eg, the failure to consier the company’s separate interests (that being of the creditors) in Kinsella meant that thre was a breach of the duty.) The interests of the company as a whole is usually the shareholders interests but requires a consideration of all classes not just block-holders (Greenhalgh; Ngurli; Whitehouse). ‘Company as a whole’ doesn’t mean company as distinct from corporators (Greenahlgh). Directors may properly balance considerations of shareholders in short-term and long-term (eg in Darvall where directors rejected takeover offer, even though shareholders in shrot-term wanted to sell, because directors had in mind transactions which would bring greater benefits to shareholders in long-run). Duties to consider include:

      1. Existing members (cf s 461(1)(e) oppression remedy)

      2. Interests of future members

      3. Creditors (Kinsella). Directors are unable to do anything that prejudices creditors when company is insolvent or nearing insolvency (Bell) (cf duty to prevent insolvent trading s 588G; no ratification of damage to creditors Kinsella)

      4. Corporate groups (Walker v Wimborne; S 187 wholly owned subsidiary – where director of a co that is a wholly-owned subsid, won’t breach duty if (a) constitution expressly authorizes director to act in best interests of holding co and (b) director acts in good faith in best interests of holding co and (c) subsidiary not insolvent at time director acts and doesn’t become insolvent because fo that: s 187.

      5. Employees: in Parke

      6. Where classes of members have inconsistent interests (cf shareholders remedies, oppression remedies or statutory derivative action, relief if board unfairly prejudicial or discriminatory in relation a member; leagues case)

   3. Third – for proper purposes:

1. Onus on complainant: Even if no duty to speak initially by exercise of power (eg refusal to register) duty may arise from circs pointing if unexplained either affirmatively to existence of unjustifiable reason or negatively to absence of legitimate reason: Ure.

2. Two steps: (1) identify purposes for which power may be exercised; (2) determine as fact the purpose for which power was exercised in case (Howard Smith), and whether ‘but for’ that improper purpose director would have acted (Whitehouse) [Where there are dissenting directors and the majority directors do not all share the same purpose(s), court must ascertain the substantial purpose of the majority directors, even though the majority of the majority may be a minority of board: Harlowe's.

3. Directors can consider long-term interests over short-term interests of shareholders (Darvall; directors defended a takeover bid because the offer was unreasonably low). Also in Teck (cited in howard smith ) where the directors entered into a transaction that involved issuing shares not to defeat another competitor’s attempt to obtain control, but rather to allow the co to obtain the best agreement it could while still in control.

4. Controversy over proper purposes for the share issue power: Power cannot be used to entrench the existing directors, displace an existing majority, alter voting rights, or fight off a takeover for the sake of maintaining control (Howard Smith). Eg where director believed co in better hands of sons than daughter (Whitehouse).

   1. However, is it improper where the directors honestly believe that it is for the good of the company to defend a takeover? In Hogg it was held that this honest belief did not prvent the issue from being improper (Hogg;).

   2. However Teck and Cayne have suggested a limitation to this: being that where the object of the share issue is nott o allow the directors to retain control because the directors believe they are better directors than their rivals, but is because the directors honestly believe on reasonable grounds that the competitor will run down the company (reduce it to ‘beggary’) it was permissible.

Re (1) characterising power and legitimate purposes for which exercised:

1. Power - Issue shares? (check constitution Whitehouse);

   1. Can issue shares to: raise capital, foster business connections (Harlowe’s); provide employees with an incentive through an employee share plan, pursuant to a dividend reinvestment plan, or capitalize profits by issuing bonus shares (Mills v Mills), in consideration for purchase of an asset (Winthrop). (ie must be a legitimate commercial objective: eg in Harlowe’s - If directors’ purpose is to obtain best agreement for realizing company’s assets, then that can be a legitimate purpose for influencing control. Eg in Harlowe’s - directors issued shares partly paid and couldn’t have sued to get rest because co was a no liability co. But Court found that the directors purpose was to give co freedom to plan with company it issued shares with and ensured its long-term stability, rather than impermissible purpose of defeating mystery takeover buyer.

   2. Cannot issue shares to: displace an existing majority or fight off takeover: Howard Smith; to entrench the existing board of directors (Whitehouse v Carlton – where director wishes to manipulate voting power to ensure that favoured sons would retain control because he believed his sons would be better managers); to discriminate against particular shareholders or classes of shareholders (Mills v Mills); Cannot issue only to benefit self (Ngurli). Cannot issue shares to manipulate voting power to ensure that

2. Power - Register transfer of shares? Can take into account whether transferee’s character is such that membership would reflect adversely on the company’s reputation: Ure. (in Smith and Ure – power to refuse registration valid, but constitution permitted this).

3. Power – Transactions (Teck; Offered contract to another and if directors elected to do work would be allotted shares. This defeated another co which wanted the work and to...