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Duties and Obligations of Directors

Undertaking obligations as a director and assuming the companies operations requires careful consideration, even on the board of a small company. It is a requirement of the Corporations Act that each company has at least one director.

Even the directors of small, closely-held companies are accountable to the same standards of probity and diligence required by the law as directors who run large public companies.

What are the key Director duties?

Broadly speaking, director duties fall into two categories – namely, general obligations of a fiduciary nature and the positive duty to prevent your company from trading while insolvent.
General duties imposed by the Corporations Act include to:

• exercise powers and duties with the care and diligence of a reasonable person;
• exercise powers and duties in good faith in the best interests of the company and for a proper purpose;
not to improperly use your position to gain an advantage for yourself or someone else, or to cause detriment to the company; and
not to improperly use information obtained through your position to gain an advantage for yourself or someone else.

Ignorance is no excuse

You may recall the famous Centro case (ASIC v Healey & Ors [2011] FCA 717) where the board did not examine the group’s financial accounts with proper care and attention and, as a result, they failed to spot a multibillion-dollar error.

The error itself was a technical (albeit significant) misclassification of borrowings as non-current liabilities when they were actually current. The accounts had been prepared by a major accounting firm and the directors argued that they could not be expected to know that the liabilities in question were current liabilities within the meaning of the relevant accounting standards.

Respecting that not all directors are qualified accountants, the Court still found that the general obligation to act with care requires directors to look critically at financial statements and to understand basic accounting standards. This is not to say they need to be experts, but they do at least need to review, understand and, if necessary, query and correct. It is not sufficient to engage a third party to do this for you.

While good governance involves seeking out appropriate expertise; the duty to exercise care and diligence cannot be outsourced.

Financial responsibilities

Depending on the size of your business, you may not be involved in day-to-day transactions or maintaining the accounts.

This does not matter in the eyes of the law. In fact, under the Corporations Act a director can be held personally liable for insolvent trading. The board has a positive obligation to understand the company’s finance.

In practice this means that before you incur a new debt, you must consider whether you have reasonable grounds to suspect that the company is insolvent or will become insolvent as a result of incurring the debt.

Penalties

Breach of good faith, misuse of position and misuse of information are criminal offences with a penalty of $340,000 and/or five years jail.

Recently a Melbourne-based director was jailed for three years after pleading guilty to dishonestly and recklessly using his position as a director to cause detriment to the company.

Director Garry Matthews operated a carpet business in Mount Waverley.

ASIC’s investigation found Mr Matthews used his position as director to authorise the withdrawal of numerous bank cheques totalling $1,075,300 belonging to the company for his personal use.

Can we insure against claims?

Although public liability insurance will cover your organisation against claims for wrongful acts, individual directors are not covered, and would need to be covered with directors’ insurance. Commonly called D&O insurance, this cover can be an effective means of transferring risk to the insurer.

This cover is limited to ‘good faith’ type breaches and will not cover willful breach of duties not to improperly use position or information (including a breach of the type committed by Mr Matthews, above).

Directors can further reduce their risk of personal liability by obtaining a deed of indemnity and/or indemnities provided by the Constitution.

Our business law team provides advice and guidance to directors on their obligations, company constitutions and risk management steps that can be undertaken to reduce risk and ensure compliance with the law.