Company Directors in the UK and Australia

‘There are no qualifications for being a company director. Even directors of listed companies do not have to take any examinations. In principle, anyone can become a director. One might therefore think that the duties of an office so unexacting in its qualifications would be simple and easy to ascertain. In fact, this is far from the case. In fact, the duties of directors can be discovered only by examining at least three different sources which lie like strata one above the other. The bedrock is the duties which directors owe at common law, or more precisely in equity, simply because they are managing other people’s property. Over that layer has been imposed a number of specific statutory duties intended to reinforce the duties at common law. And over that layer has been imposed still further duties under various self-regulatory codes, which are also intended to reinforce the common law duties in areas not thought suitable for legislation’.

Discuss the above statement in light of the position of company directors in the UK and Australia.

Introduction

A company being a legal entity can only act through natural persons to run its affairs. Director is the person on whose behalf the company operates. They are professionals, hired by the company and are not the employee of the company. The title ‘director’ implies a position that is highly eminent and prestigious. “It is not the name but by functions but by duties where one is described as director. It is only when a person is duly, appointed by the company to contract in the company’s name and, on its behalf that one functions as a Director. Further the company’s article may designate its Directors as governors, the board of management, but under the law they are simple Directors.” [1] A director is responsible for managing the business and affairs of the company and also along with company secretaries that the company complies with the companies’ act 1985.

In the book of law, there is no criterion as to skills or qualification of persons for being a director of the company neither in the UK nor in Australia. Even directors of listed companies do not have to take any examinations. In principle, anyone can become a director. One might therefore think that the duties of an office so unexacting in its qualifications would be simple and easy to ascertain. Having said that, no matter how prominent and unexacting the title director may sound, the law does not treat the position as just another step up the management ladder. [2] Indeed, the duties of directors can be discovered only by examining following sources. Part I discusses Strata one above the other, to whom are directors’ duties owed? Part II is Equitable Fiduciary duties. Part III explains Common law duties. Part IV discusses statutory duties and its codification. Part V discusses breach of Duties and exceptions to it. Part VI discusses the above duties in light of the position of Director in UK and Australia. And Part VII is conclusion.

I. Strata one above the other and to whom are directors’ duties owed?

There has been much debate as to whether all officers are equal or whether there are some distinctions based upon the precise position held, such as chief executive or chair of the board. The general consensus is that all officers are equal in their duties but the level of skill and care expected may change depending upon the position held. There are various types of company officers, including the chairperson, managing director, Chief financial officer and non-executive directors.

In a particular case the officers (such as the chair of the board) may have certain powers and responsibilities, such as participating on special committees (for example the audit committee). The possession of particular powers and responsibilities will be taken into account when determining whether the directors have complied with the duty of care, skill and diligence (and its statutory equivalent in s 180(1)). In ASIC v Rich (see below) the chairman, Mr Greaves, was held to hold a special position that must reflect his skills and diligence. This has also been applied to a chief financial officer in the case ASIC v Vines. [3]

“The question of “to whom are the duties of directors owed is normally answered by the phrase ‘to the company as a whole’. “This was interpreted by the UK Court of Appeal as meaning not the company as an entity outside and apart from its shareholders, but rather the general body of shareholders: Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286.” [4] In short they owed to the collective body of shareholders and not to particular shareholders individually, unless the nature of the relationship between particular directors and particular shareholders has been said to be fiduciary in nature so that fiduciary obligations are owed by those directors to those shareholders.

There has been a consistency by the court for holding that Directors do not owe a duty to consider the company’s employees ahead of shareholder interests. However, part 5.8A of the Corporations Act now provides for director liability where they have allowed the company to enter into a transaction designed to defeat worker entitlements. [5] To keep the interest of the company paramount, directors owe duties towards Nominee directors as they are an example of a director who is appointed by a particular shareholder to represent their interest. They do owed duties to the corporate groups and creditors because they play an important role in the continuing success of the company and provide funds to assist the company with acquisitions and expansions and to manage its cashflow.

II. Fiduciary/equity

“All fiduciaries (including company directors) have an obligation to act in good faith and in the best interests of their principal (for directors and officers the principal is the company). The meaning of the term ‘in the best interests’ of the company involves a consideration of ‘who’ the company is for the purposes of the law.” [6] “POWER held by fiduciaries is subject to many forms of control. All of these forms of control have to strike a balance between competing objectives. They must seek to curb the harm that the holder of power can inflict on those affected by it. Yet they must be careful not to abolish the discretion inherent in power itself.” [7]

“Directors, like partners, trustees and agents, always owe a fiduciary duty to those persons who are vulnerable to their actions and who may be easily harmed. That is, directors and other officers owe a fiduciary duty to the company because it is vulnerable to their actions and relies on the directors and officers to act properly. As a fiduciary, there are four central obligations governing corporate behaviour:

1. To act in good faith, in the best interests of the company;

2. To avoid conflicts of interest;

3. To not make a secret profit; and

4. To act for a proper purpose.

All officers must avoid breaches of these equitable fiduciary duties, and a breach may result in the officer becoming a constructive trustee. This means that all proceeds that the officer has obtained from the breach of duty would be held on trust and returned to the company. Alternatively, the officer may be liable to pay equitable damages or the company may rescind any contract that was improperly made by the officer. In addition to these equitable remedies, officers may also be liable for civil or criminal penalties under the Corporations Act because these equitable duties are largely reproduced in ss 181–183″ [8]

Good faith

A requirement that fiduciaries should act in good faith is central. [9] To speak of a “duty to act in good faith”, however, can easily conceal an important distinction. If that distinction is not made, confusion can easily follow. Sometimes, the fiduciary’s “duty to act in good faith” can mean that the fiduciary has a duty to do something particular in a certain way. For example, a director may have to disclose his own wrongdoing. [10] In other contexts, the same words may mean that the fiduciary has power to act, but no duty, yet if he does exercise that power, he must do so in good faith. [11] This article is concerned with the latter situation, where good faith qualifies the exercise of power, rather than demanding specific action.

Conflict of interest

Directors’ fiduciary duties are concerned with preventing the abuse of powers to promote their self-interest. “In the United Kingdom, directors, in carrying out their duties (of exercising power and discretion given to them), are obliged to adhere to their overriding duty of good faith and to act in the best interest of the company. Fiduciary duties forbid directors from placing themselves in such a position that their personal interest conflicts with the company’s, as they are required to give their exclusive attention to the company.” [12] For example it was held in the case, Cook v Deeks, [13] several directors including two Deeks brothers and another director) of the Toronto Construction Company had a disagreement with one of the other directors (Cook). The directors then negotiated a major construction project on behalf of the company, but diverted that project to a new company that they had established in an attempt to exclude Cook from the project (Cook was neither a shareholder nor director of the new company). The directors then used their shareholdings to pass a resolution at a members’ meeting declaring that the company (that is Toronto Construction) had no interest in the project, effectively freezing out Cook from the project. Issue was, did the directors breach their fiduciary duty by giving the business opportunity to the new company rather than Toronto Construction? And the decision given was, the directors acted in breach of their fiduciary duty and the shareholders’ resolution was invalid because the directors/shareholders were acting under a conflict of interest. “As the court said (at 563): directors who assume the complete control of a company’s business must remember that they are not at liberty to sacrifice the interests which they are bound to protect, and, while [apparently] acting for the company, divert in their own favour business which should properly belong to the company they represent.” [14] “In another case Bray v Ford [1896] [15] House of Lords it was held that it is an inflexible rule of a Court of Equity that a person in a fiduciary position, such as the director of a charitable company, is not, unless otherwise expressly provided, entitled to make a profit. The director is not allowed to put himself or herself in a position where his or her interest and duty conflict. Similar comments were made by Lord Upjohn in Phipps v Boardman”. [16]

Directors must not permit their personal interests to conflict with their duty to the company. This self-dealing rule prohibits a director from acting where his personal interests conflict with his duties. A director’s main aim should be to promote the interest of the company, which, in case of conflict, should be preferred against his own interest. [17] Malins, V.C., ably stated the principle when he described it in the following terms: it is the duty of directors of companies to use their best exertion for the benefit of those whose interests are committed to their charge, and that they are bound to discharge their own private interests wherever a regard to them conflicts with the proper discharge of such duty. [18]

Secret profit

“The position of a director inevitably provides him with an opportunity to make gain, but his fiduciary duty prohibits him from retaining benefits, which must be accounted to the company. The exception is where a director makes a personal contract offer after an offer is made to the company but the board decide not to take it. Moreover, the director’s liability to account does not depend on the proof of bad faith. . Equity discourages a director from entering into a contract where his personal interest conflicts with the interest of those he is required to protect. [19] When a director is negotiating a contract, he cannot resign from a company to take the benefit of the contract, and if he does so, he will be required to surrender the profits he makes. [20]

Act for purpose

Strictly applied, the proper purpose doctrine requires the directors to exercise the powers of the company for the purposes for which they were originally conferred. In Australia, it will suffice if the power is exercised for the benefit of the company as a whole to constitute the power having been exercised for proper purpose. [21]

The fiduciary duty of directors requires them to exercise their powers for a proper purpose. For directors to use their powers for a proper purpose requires them to use their powers bona fide for purposes for which their powers were conferred upon them. The courts took pain in trying to define the meaning of “proper purpose”. Issuing shares to raise capital for the benefit of the company will come under the umbrella of proper purpose, but not if the intention of the director is to preserve his own control or to forestall a takeover bid, [22] or to maintain control of the board of directors and their friends over the affairs of the company or merely for the purpose of defeating the wishes of the existing majority shareholders. [23] Cases which can be referred for the same are Hogg v Crampton Ltd [24] and Piercy v S Mills & Co Ltd. [25]

III. Common law (of loyalty, obedience, mutual trust &confidence, care and skill)

“The common law duty of care, skill and diligence that is expected by the courts has traditionally been set at a very low standard. The basic test, which can be contrasted with the higher modern test in the AWA cases discussed below, was laid down in Re City Equitable Fire Insurance Co Ltd [26] . In that case, Romer J (whose judgment was approved of by the UK Court of Appeal) considered claims made against the directors of an insolvent company who had signed fraudulent cheques produced by the managing director. The issue, therefore, was whether the directors had breached their duties by failing to detect the fraud before signing the cheques. The significance of the case lies in the principles that Romer J provided for assessing the duty of care and diligence. “Directors must exercise such degree of skill and diligence as would amount to the reasonable care, which an ordinary man might be expected to take, in similar circumstances, if the business were their own. However, directors need not exhibit in the performance of their duties a greater degree of skill than may reasonably be expected from a person of their particular knowledge and experience.

Directors are not bound to give continuous attention to the affairs of the company because the duties of directors are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee to which the directors may be appointed, and though not bound to attend all such meetings the directors should attend them when reasonably able to do so. Directors may properly rely on the actions of company officials, unless there are reasonable grounds for suspecting that the officials are not adequately performing their roles.” [27]

“Some duties are applied exclusively to directors. For instance, a specific example that is applied to directors (and not all officers) is the positive duty to not trade while the company is insolvent as required by s 588G.This provision is an enhancement of the common law duty to consider creditors in times of financial trouble, as affirmed by the High Court in Spies v R (2000) 201 CLR 603; [2000] HCA 43.” [28]

“Owing allegiance to the traditional practices the level of care and skill which are demonstrated by a director has been framed largely in the context of non-executive director. A cursory look at the case “In Re City Equitable Fire Insurance Co [29] ” assumes importance over here as the court held: “a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.” However, it needs to be stated over here that this decision was based firmly in the older notions existing at the time when mode of corporate decision making and effective control residing in the shareholders; persisted. A more contemporary approach can be seen in Dorchester Finance Co v Stebbing [1989] [30] where the court held that the rule in Equitable Fire relates only to skill, and not to diligence. As far as due diligence is concerned the rule implies that “such care as an ordinary man might be expected to take on his own behalf” assumes importance. This was perceived as a subjective and objective test and it deliberately pitched at a higher level.” [31]

“Furthermore, recently it was remarked that both the tests of skill and diligence should be assessed objectively and subjectively. In this light in the United Kingdom, new Companies Act 2006 codified the statutory provisions relating to directors’ duties. [32] General common law duties imposed on directors in various circumstances enshrine a duty to carry out tasks with reasonable care and skill. It can be interpreted on this basis as the duty of reasonable care and skill of someone who is competent to do the job and does not convey to mean that one has to do the task ‘to the best of one’s incompetent ability’.

The contract of service for the executive directors implies some common law terms which find reference into all contracts of employment and are further designed to protect the director as an employee of the company. Directors are bound by the duty of mutual trust and confidence which they owe to the Company (and vice versa) in the context of the employer/employee relationship. These duties however stand in direct contrast to the fiduciary duties outlined above which apply to the director’s office when he holds responsibility. An as example duty of mutual trust and confidence is one such duty. This duty, the Directors as officers of the company owe to other directors as employees of the company. Over here, the issue arises when an executive Director brings a complaint of unfair dismissal or under the circumstances when the company seeks to remove an executive director.” [33]

Companies will never be contended to rely on the common law and therefore place a lot of significance to codified terms which are set into a contract of employment. But it should be embarked that the contract of employment is not always definitive and the courts as a general practice infer the existence of implied terms by relying on what they see as ‘reasonable’ in the circumstances. [34] “Officers, like directors, owe a duty of loyalty to the corporation and its stock holders. This duty does not arise solely by virtue of director or officer status; it is a duty owed under general principles of agency Law.” The duty of loyalty is of general applicability, but most frequently affects officers in the areas of corporate opportunity, competition with the corporation/ employer, and use of corporate trade secrets. One aspect of an officer’s fiduciary duty of loyalty is the duty not to usurp an opportunity that is rightfully the corporation’s. Thus, an officer must refrain from buying for himself that which he was instructed to buy” [35]

IV. Statutory Duties and its Codification.

“In the UK, the Company Act 2006 introduces a statutory statement on directors’ duties which covers the following general duties:

(a) duty to act within powers;

(b) duty to promote the success of the company;

(c) duty to exercise independent judgment;

(d) duty to exercise reasonable care, skill and diligence;

(e) duty to avoid conflicts of interest;

(f) duty not to accept benefits from third parties; and

(g) duty to declare interest to proposed transaction or arrangement.

The above mentioned sections are extracted at Appendix III. While the statutory duties replace the corresponding common law rules and equitable principles from which they derive, these duties are required to be interpreted in the same way as common law rules and equitable principles. In other words, the courts should interpret and develop the general duties in a way that reflects the nature of the rules and principles they replace [36] . This approach displays the UK Government’s intention to achieve both the precision of the statutory statement and the continued flexibility and development of the law. The statutory duties do not cover all the duties that a director may owe to the company. Many duties are imposed elsewhere in the legislation, such as the duty to file accounts and returns to the Registrar of Companies. Other duties remain uncodified, such as the duty to consider the interests of creditors in times of threatened insolvency.

The remedies for breach of the statutory general duties have not been codified in the CA 2006. The CA 2006 states that the same consequences and remedies as are currently available should apply to breach of the statutory general duties [37] . Where the statutory duties depart from their equitable equivalent, the court must identify the equivalent rule and apply the same consequences and remedies.

The UK goes beyond simply codifying the existing common law rules and equitable principles on directors’ duties. It also attempts to modernize the law by introducing the principle of “enlightened shareholder value” under the duty to promote the success of the company. The duty requires a director to act in the way which he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and, in doing so, having regard to a list of wider factors, such as the interests of employees, suppliers and customers and the impact of the company’s operation on the environment [38] . The list is not exhaustive, but highlights areas of particular importance which reflect wider expectation of responsible business behaviour. The duty does not require a director to do more than good faith and reasonable care, skill and diligence [39] . On the other hand, Australia has also adopted statutory statements of directors’ general duties. Statutory duties of directors have been introduced in Australia since 1991 and are mainly contained in sections 180 to 183 of the ACA. In addition to common law relief, additional consequences, such as civil penalties, disqualification orders and criminal convictions, may stem from breaches of the statutory directors’ duties. The Australian approaches differ from the UK’s in that the statutory duties in the ACA have effect in addition to the existing common law and equitable principles and therefore the common law rules and codifying statute can be used together to develop the law [40] .

“An example of a director being held liable for all three types of actions occurred in South Australia State Bank v Clark [41] . In that case, the CEO was held liable for breach of negligence (a common law duty), breach of equity through a conflict of interest and contravening his statutory duties as a director.” [42]

V. Breach of duties and exception to it.

“This section considers precisely what the courts can do in response to quash the exercise, or purported exercise, of power by a fiduciary. It does not address the personal liabilities which attach to the holder of the power or those who dealt with him. The pattern of these responses is clear: as should be expected, they reflect the reasons why some exercise or purported exercise of a power may be impugned.” [43]

A classic example of this is Cloutte v. Storey [44] , a power of appointment was purportedly exercised over a trust fund, but the appointment was actually in fraud of the power. The beneficiaries in default of appointment claimed that they were still entitled to the fund as against the assignee of the purported appointee. They won: the purported appointment was void, and so created no equitable title to the fund. The Court of Appeal did recognise, however, that if legal title to the trust assets had been transferred to the purported appointee, that would have been effective, and an assignee of that legal title might be able to make out a defence of bona fide purchase of the legal title for value without notice, so as to defeat the equitable rights of the beneficiaries in default of appointment. In fact, this is the consequence precisely presaged in Cloutte v. Storey [45] . That case considered (albeit strictly obiter) the exercise of a power to appoint a legal estate in land, as was possible before 1926, [46] rather than a power to allot and issue shares. Still, the key point for present purposes is that Farwell L.J. explicitly addressed the improper exercise of a legal power – a power which operates to create a legal proprietary interest. He confirmed that such an exercise of the power would be voidable: as a matter of authority, equitable doctrine did not go to define the scope of the power, so equity had to recognise the effect of the power to create new legal property and then reverse that effect.

As per “The Corporations Act 2001 liability is imposed on a director of a company when:

a) The company is insolvent at the time that the debt was incurred; or b) Where reasonable ground exist with director’s awareness that the company was, or may become, insolvent due to of incurring the debt, often referred to as “insolvent trading”. Upon directors finding that the company cannot pay its debts company is required to:

a) Appoint an administrator;

b) Apply to the Court for the appointment of a provisional liquidator; or

c) Apply to the Court to wind up the company and appoint a liquidator.

Despite the fact of having more assets than Liabilities Company can still be declared insolvent. In Re Ipcon Fashions Ltd [47] , it was held that Director’s cannot sell company’s asset to save their and their employees jobs. However, in Re CU Fittings Ltd [48] , it was stated, sale entitli