LAW- Case Study 2000 Words

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LAW205 Commercial & Corporate Law for Accountants

Corporate Governance and Directors’ Duties (Part I)

Week 4

CHAPTER 6

MANAGEMENT OF COMPANIES

At the end of this topic you should know:

how power is divided between the board of directors and the company in general meeting;

what the term “corporate governance” means and what are some of the commonly debated corporate governance issues;

the types of directors a company may have and how directors can be appointed, remunerated, removed from office, and disqualified;

director’s rights to obtain access to company records; and

the duties of the company secretary.

Division of Powers Within a Company Board of Directors

A company is an artificial legal entity – a creation of law. As such, people must act for and on behalf of the company. Persons authorised to act on its behalf become the “organ” of the company.

The organs of most companies will be the board of directors and the members in general meeting. The internal rules usually provide that the main organ of the company is the board of directors: s 198A.

Division of Powers Within a Company General Meeting

The general meeting becomes the organ of the company when the company’s powers are expressly granted to the general meeting by either:

the Corporations Act;

the company’s internal rules; or

ASX listing rules if applicable.

Residual power may also fall to the general meeting. Where the constitution is silent as to who can exercise a particular power of the company, the general meeting will probably be the relevant organ.

Division of Powers Within a Company Board vs Members

Where a company’s internal rules include s 198A or a similar rule, the members in general meeting cannot give directions to or overrule any action of the board on how to exercise its powers of management: Automatic Self Cleansing Filter Syndicate Co Ltd v Cuninghame [1906].

However, the general law has vested residual power to act for the company when:

the board is unable to act;

the board has power to ratify breaches of duty; and

the directors refuse to initiate action against themselves for breaches of their duties.

Division of Powers Within a Company Single Director/Shareholder Companies

Sections 198E and 201F removes the conventional division of powers for single director/shareholder companies.

Section 198E(1) provides that the business of the company is to be managed by or under the direction of the director.

Section 201F empowers the single director to appoint another director by recording the appointment and signing the record.

Division of Powers Within a Company – Summary

Corporate Governance

Corporate governance is a dynamic and evolving institution which attempts to provide a structured and binding framework for the resolution of disputes and conflicts involving members, company officers and other interested parties.

Corporate governance lays down the rules which are designed to ensure accountability, particularly from company officers, and to promote the objectives of transparency and enhanced shareholder value.

Corporate Governance Debates, Reforms and Future Proposals

Originally, much of the debate centred around the question of whether increased statutory regulation was preferable to self-regulation.

Government policy in Australia has been to introduce more stringent statutory regulation as a means of achieving higher standards of corporate governance, as least in respect of audit, financial reporting, continuous disclosure, and margin lending.

More recently, debate has centred on whether current disclosure requirements for reporting entities have in fact achieved the desired goals of market transparency and market integrity.

Corporate Governance Debates, Reforms and Future Proposals

In recent years, there has been increasing debate in Australia and overseas about corporate governance issues in relation to public companies.

The recent Global Financial Crisis has led to calls for improving corporate governance standards, particularly with listed companies.

For a summary of the proposed reforms see [6.130].

Types of Directors

The terms “director” and “company officer” are defined broadly in the Corporations Act to cover both appointed directors as well as “shadow” directors and “de facto” directors: s 9.

Other non-statutory directors include:

nominee directors;

executive directors;

non-executive directors;

managing directors; and

alternate directors.

Management Positions

Management

positions in

companies (may

overlap)

Director s 9

Secretary

(no statutory

definition)

Officer

s 9

Formally

appointed

Not

appointed

De facto

Shadow

Includes director,

secretary and other

persons in management

CHAPTER 11

DUTIES OF DIRECTORS AND OTHER OFFICERS PART 1 – Duty of Care, Skill and Diligence

At the end of this topic you should know:

the duties imposed on directors by the general law and by the Corporations Act;

the remedial consequences which result when directors breach these duties;

the conduct expected of directors under the duty of care, skill and diligence;

the conduct expected of directors under the duty to prevent insolvent trading; and

the overlap between the last two duties.

Introduction Reasons for Directors’ Duties

The duties fall into three broad categories:

the duties of care, skill, and diligence;

the duties of good faith and proper purpose; and

the duties to avoid conflicts of interest and to provide proper disclosure.

Directors’ duties reduce the temptation and/or risk of fraud or mismanagement. They also create tension between commercial and legal expectations of directors.

Balancing Directors’ Duties

Policy Considerations

Comply

with legal

duties

Directors’

functions

Commercial

Legal

Improve

performance

of company

Debate

During the 1990s some commentators argued that the balance was weighted too much in favour of legal compliance, at the expense of company performance.

The debate about the extent of legal regulation of companies reflects a concern that people who are most well-informed about their legal responsibilities may become reluctant to take on the role of a director for fear of personal liability.

Why Directors Owe Duties

Directors owe duties of good faith and loyalty because they are in a “fiduciary relationship” with their company: Elders Trustees and Executor Co Ltd v E G Reeves Pty Ltd (1987).

A fiduciary relationship exists:

where a person is appointed to or assumes to act;

for the benefit of another person; or

in circumstances where the appointment gives the appointed person powers which could be exercised to the detriment of the other person.

Outline of Duties of Loyalty and Good Faith

The duties of good faith and loyalty can be broken down into four overlapping sub-duties:

the duty to act in good faith;

the duty to exercise one’s powers for proper purposes;

the duty not to fetter one’s discretion; and

the duty to avoid actual or potential conflicts.

Outline of Duties of Care, Skill and Diligence

The second group of duties owed by directors comprises the duties of care, skill, and diligence.

There are two sub-duties:

the duty to exercise reasonable care, skill, and diligence; and

the duty to prevent insolvent trading.

Who Must Perform the Duties? Sources of Duties – Directors and Officers

The duties of good faith and loyalty, and care, skill and diligence arise under:

the general law; and

Pt 2D.1 of the Corporations Act.

These duties apply to directors but may also apply to other officers of a corporation.

To Whom are the Duties Owed? Legal Consequences

The duties are owed to the company as a whole: Mills v Mills (1938), but in special circumstances, may be extended to members, creditors and beneficiaries of trusts.

It is quite common for a director to be sued under the Corporations Act and alternatively under the general law for breaches of directors’ and fiduciary duties.

A director who breaches their duties may be sued by: the company; a liquidator; a creditor; a shareholder; and ASIC.

Legal Consequences

Both the general law and the Corporations Act provide for the court to make orders against a director committing a breach of a director’s duty. These orders are of two broad kinds:

remedies (general law, and statutory); and

penalties (civil and criminal).

Duty of Care, Skill and Diligence

The director’s duty of care arises under:

the director’s contract of employment (if any); and

the general law; and

s 180(1) of the Corporations Act.

Under the Corporations Act, the standard of care is assessed by reference to: the company’s circumstances; the position and responsibilities of the director or officer; and the experience of the director or officer.

Duty of Care, Skill and Diligence

While the duties of care owed by directors under general law and s 180(1) are substantially similar in meaning and effect, there are some differences between them.

To determine whether a director has complied with or breached their duty of care, it is necessary to compare the director’s actual conduct against the standard of conduct expected of the director by the director’s duty of care.

Reasonable care suggests an objective standard, but it may vary depending on size and type of business, as well as the experience, knowledge and skill of the director: AWA Ltd v Daniels (1992).

Daniels v Anderson (1995) 37 NSWLR 438 Directors duty of care, skill and diligence:

Directors should:

have a basic understanding of the business of corporation and be familiar with the fundamentals of the business;

keep informed about the activities of the business

must not ‘fall asleep’ or shut their eyes to corporate misconduct

generally monitor corporate affairs and policy and should attend board meetings regularly

be familiar with the financial status of the corporation by regular review of the financial statements with a duty to inquire on any further matters revealed

not hide as a ‘dummy’ director

not be a ‘sleeping’ director

acquire further knowledge or refuse to act – it is not sufficient to say he/she does not have sufficient experience/expertise.

Duty of Care, Skill and Diligence

Directors are expected to possess certain basic skills in relation to financial statements and financial affairs of their companies: Cth Bank v Friedrich (1991).

The element of “diligence” requires directors to take reasonable steps to place themselves in a position to monitor and guide the management of the company: Daniels v Anderson (1995).

Diligence by a director includes: attendance at all board meetings, basic understanding of the business, and obligation to keep financially and generally informed of the business: ASIC v Hellicar [2012] – a James Hardie case; ASIC v Healey [2011]; ASIC Media Release: Centro Civil Penalty Proceedings.

Duty of Care, Skill and Diligence

Four currently contentious issues which impact on the way in which directors discharge their duty of care are:

difference in the functions of the boards;

differing responsibilities of executive and non-executive directors;

delegation of functions and reliance by directors on other officers: ss 198D, 190, and 189; and

differences between entrepreneurial risk taking and failing to act with care.

Duty of Care, Skill and Diligence General Law:

Non-executive directors: ASIC v Rich (2003)

Delegation of functions and reliance on other officers: ASIC v Adler (2002); ASIC v Macdonald (No. 11) (2009) 71 ACSR 368 - a James Hardie case

Chief Financial Officers: ASIC v Vines (2003); ASIC v Macdonald (No. 11)

Company secretary: Shafron v ASIC [2012]

- a James Hardie case

The Business Judgement Rule

A judgement is taken to meet the statutory and general law duties of care, skill and diligence if the director or officer:

made it in good faith and for a proper purpose;

did not have a material personal interest;

informed themselves about the subject matter to the extent they reasonably believed it to be appropriate; and

rationally believed that it was in the best interests of the corporation.

Duty to Prevent Insolvent Trading

A person engages in insolvent trading in breach of s 588G if:

the person is a director of a company when the company incurs a debt; and

the company is insolvent at the time of incurring the debt; and

there are reasonable grounds for suspecting that the company was insolvent, or would become insolvent at the time the debt was incurred: and

the person is aware of such grounds, or a reasonable person in like position and same circumstances would be aware; and

the person fails to prevent the company from incurring the debt.

Duty to Prevent Insolvent Trading

A director may rely upon any one or more of four possible statutory defences in s 588H if:

the director could and did reasonably expect that the company was solvent at the time and would remain solvent, even if it incurred the debt; or

the director expected that the company was solvent, on the basis of information supplied to her or him by a subordinate the director believed on reasonable grounds to be competent, reliable and responsible for providing adequate information about the solvency of the company; or

Duty to Prevent Insolvent Trading

the director, because of illness etc, did not take part in the management of the company at the relevant time; or

the director took all reasonable steps to prevent the company from incurring the debt: s 588H.

Shareholders Directors

Power to remove directors from

office

Power to ‘recommend’ dividends

Power to approve director

remuneration

Management powers

Shareholders	Directors
Power to remove directors from office	Power to ‘recommend’ dividends
Power to approve director remuneration	Management powers