A company is an entity incorporated under the Corporations Act 2001 (Cth) (the ‘Act’). The effect of incorporation gives the company a separate legal entity, distinct from its directors and shareholders. It can enter into contracts, sue and be sued in its individual right.
The Australian Securities and Investments Commission (ASIC) is the Government body authorised to administer the Act and may investigate and impose civil and criminal penalties for breaches under the Act.
If you are forming a company, whether to run your business or to manage a family or unit trust you will likely become a director of that company. Alternatively, you may have been offered a director’s role for a large corporation. Either way, directors have significant responsibility and an overriding duty to act in the best interests of the company they represent.
All directors should be familiar with their duties and responsibilities which are set out in the Act and derived from the general law.
The duty of good faith
A director’s relationship with the company imposes a position of power and trust. A director is authorised by law to act for the company. Directors therefore have a fiduciary duty to the company they manage, meaning they must act honestly, in good faith and in the best interests of the company. A director’s position should be used for the benefit of the company and not for purposes of personal gain.
Case law has determined that the best interests of a company are generally served by the action and management direction the directors ‘honestly believe’ appropriate at the time. The duty is owed to the company as a whole – not necessarily the majority of nor individual shareholders. The interests of the company, its shareholders and creditors must take priority over a director’s personal interests.
Criminal penalties may be imposed on a director whose conduct has been reckless or intentionally dishonest.
Duty of care, skill and diligence
These duties generally overlap and can be considered together. The level of skill required to be exercised is usually determined by the qualification of the director. A director being an expert in a certain area would be expected to exercise such a skill for the company’s benefit. A director however is not expected to demonstrate a skill which he or she does not have.
Similarly, the level of diligence depends on the surrounding circumstances however care and discretion should always be exercised. This will be considered in the board’s composition and the duties allocated to the positions held, the company’s constitution and the size and nature of an enterprise.
Diligence requires the monitoring and guidance of the management of a company which in practice includes attendance at board meetings, knowledge of the company’s business activities and regular review of financial and general affairs.
The duty of care, skill and diligence requires careful consideration as this is an area where ‘silent’ or ‘paper’ directors may be found guilty of breaching their duties. It is important to realise that, if you sign on as a director of a company, your name will be publicly available through a search of the ASIC records. Accordingly, you will likely be implicated should the company run into trouble. As a director, it is critical that you are informed of the company’s financial affairs and activities even if not managing the company’s business on a daily basis.
Avoiding conflicts of interest and misuse of information or position
The information obtained through your position as director should be handled with care. A duty to avoid a conflict of interest prohibits a director from gaining a personal benefit from an arrangement with the company without full disclosure to its members.
Directors should not pursue opportunities that would otherwise be available to, and in the company’s interests. For example, if two of three director/shareholders of a company formed a new company to prospect for business similar to that of the original company, then the directors of the new company may be in breach of their duty to the original company.
Directors must not use their position or information acquired in their role to gain an unfair advantage, to benefit themselves or others, or to cause a detriment to the company. In one case, a former director of a major telecommunications company used confidential information to trade shares. The director was found to have breached the Act (misuse of information), ordered to pay significant penalties and disqualified from managing companies for 10 years.
Duty to prevent insolvent trading – directors’ liability for debts
A company is an ideal vehicle to run a business enterprise. The company can enter contracts and raise funds in its own right and members’ exposure to personal liability is generally limited to amounts invested or shares unpaid. The protection afforded to directors and shareholders however has in the past been abused when companies have continued to trade despite warnings of potential insolvency. The directors enter contracts, incur debts and then subsequently fold the company leaving a trail of creditors and financial suffering behind.
As a result, the law has developed to make directors personally liable for continuing to incur debts when it is reasonably foreseeable that the company is or likely to become insolvent.
In some situations, defences may be available to a director who has breached a duty to avoid insolvent trading. There are also safe harbour provisions, which may be available for directors who take certain positive steps that are reasonably likely to result in a better outcome for the company than administration or liquidation. It is prudent for directors of companies facing financial difficulties to obtain professional advice urgently.
The Act imposes various reporting and compliance requirements on companies. Directors must ensure that these responsibilities are met. Duties include notifying ASIC of the personal details of company directors and shareholders, the company’s registered and business address and updating these details as they change.
There are also financial reporting requirements which vary depending on the size and type of corporation. Good record-keeping and financial reporting is essential to managing the company and making decisions and it is worthwhile investing in professional advice to assist with this aspect of management.
Company directors hold a position of power and trust. The risk of personal liability for breach of duty is real but manageable and should not deter you from pursuing business and employment opportunities.
The best way to meet the obligations of being a director is to become familiar with your duties, be involved in the affairs and operations of the company and to obtain professional advice and assistance when needed.
Your lawyer can assist with registering a new company, advise you of your responsibilities as a director and the ASIC reporting requirements. If you are a director of a company facing financial difficulties or in a position of potential conflict, your lawyer will discuss ways to manage these situations.
If you would like further information on your role as a company director, please contact us on 1800 618 869 or email firstname.lastname@example.org.