Directors’ Duties: How do They Affect your Business?

As a small to medium business owner, you’ve no doubt got a lot of regulations to contend with.  Almost all commercial conduct is regulated in one way or another.  However, some regulations are a little more complex.  Take directors’ duties, for example.  Directors’ duties apply to the directors of small and medium companies, in the same way that they apply to the directors of large multinationals.  Of course, the latter category of companies is a complex organism.  It requires complex laws to regulate it.  But the same is not always true of small and medium business.

Often, small and medium businesses are incorporated with only one or two directors.  In such cases, you might not feel as though the complex laws of corporate regulation are especially accessible.  In a lot of ways, that’s accurate.  Directors’ duties, which are established by the Corporations Act, can appear quite convoluted.  But, fortunately, they’ve been extensively tested before the courts.  That means we can gain a relatively clear understanding of what they demand.  So let’s take a look at what you need to do under your duties as a director.

Directors’ Duties Impose a Standard of Conduct: Here’s an Overview

It’s important to start with a broad overview, when it comes to understanding directors’ duties.  As with all laws, those surrounding directors’ duties have a purpose.  That purpose is to create a standard of conduct.  As the director of a company, you wield significant power.  You can direct that company to act as you think is best.  If you’re the sole director and shareholder, then your ideal outcome will be the same as the company’s.  But if your company has numerous directors and shareholders, things can get tricky.  Everyone may have different views as to what is best for the company, and themselves.  To ensure a fair outcome, directors’ duties step in.  There are several directors’ duties, but they can be summarised broadly under the following headings.

The directors’ duty of good faith and proper purpose

Section 181 of the Corporations Act requires directors to exercise their powers in good faith in the best interests of the company, and for a proper purpose. A power is used for a proper purpose when it is used for the reason it was given, not for some collateral aim, such as issuing shares to entrench a director’s control or to dilute a shareholder the director is in dispute with.

So what about ‘good faith?’  Good faith is a term that comes up a lot in contractual matters.  You may have even encountered it before.  Generally, good faith is closely linked to proper purposes.  At its broadest, conduct of good faith is conduct that is honestly intended to be in a company’s best interests.  Although directors may differ individually in what they consider to be prudent, they can still meet their duty if their beliefs are honestly held and lawfully implemented.

The directors’ duty of care and diligence

If you are a director, you will no doubt be aware that your position is one of significant responsibility.  The actions you take, or don’t take, can have enduring consequences on your company.  As a result, even from a common-sense standpoint, you need to be careful and diligent as a director.  That is why the Corporations Act imposes the directors’ duty of care and diligence.  This duty creates a legal obligation on directors to be proactive with their decision-making.  As a director, you need to consider the possible implications of every decision you make on your company’s behalf.  That is likely to involve consistent research, and careful consideration; hence, the duty of diligence.  To put it simply, you must do your ‘due diligence’ with regard to each decision you make as director.

The duty of care is similar, but with subtle distinction.  Diligence may be tantamount to proactively finding new resources on which to base your decisions.  Care, on the other hand, may be tantamount to reviewing the resources already at your disposal, to justify your decisions and guide your company.  That might include carefully reviewing your company’s accounts at regular intervals.  It might also include taking care to balance your liabilities against your assets.  There is no hard-set equation when it comes to care and diligence, but generally a common-sense approach will prevail.

A director who makes a business judgment in good faith and for a proper purpose, without a material personal interest, after informing themselves about it to the extent they reasonably believe appropriate, and rationally believing it is in the company’s best interests, is taken to have met the duty of care for that judgment (section 180(2)). Directors also have a duty to prevent the company incurring a debt while it is insolvent, or becoming insolvent by incurring it, where there are reasonable grounds to suspect insolvency (section 588G), subject to the safe harbour in section 588GA.

The directors’ duty regarding use of position and information

Another of the directors’ duties in the Corporations Act is the duty regarding use of position and information.  As a director, you are under a duty not to use your position, and its inherent influence, to improperly bring benefit to yourself or someone else, or to cause detriment to the company.  You could consider this to be the proscriptive side of the earlier duty of good faith and proper purpose.  The early duty essentially tells you how to act as a director; this duty, on the other hand, tells you how not to act as a director.

This duty touches on conflicts of interest, as well as directorial misconduct more broadly.  As a director, you need to subjugate your own interests to those of the company.  That means you cannot use your position as director to pursue your own financial interests; you must use your position to enhance the company’s interests.  The same applies under the duty regarding use of information.  However, in the latter, you are prohibited from using information you have acquired because of your relationship with the company, to furnish yourself with benefits, or to cause detriment to the company.

Will Directors’ Duties Govern your Day to Day Business Management?

Directors’ duties and commercial conduct are closely entwined.  As a result, the duties will undoubtedly govern your day to day company management, as a director.  However, the standard it imposes, while high, is not particularly burdensome.  Directors’ duties simply impose a legal standard along the lines of commercial best practice.  In all likelihood, if you are a careful, diligent, honest, and prudent director, your conduct will easily meet the standards required by the Corporations Act.  In that sense, your knowledge of directors’ duties won’t have too great an effect on your daily business management.  Nevertheless, it’s important to maintain a thorough understanding of the duties you owe your company.

Can Directors’ Duties Help Resolve Conflicts Between Directors?

Where there are multiple directors in one company, there are sure to be conflicts.  In many ways, that’s just part of business.  Different people have different commercial experiences.  And those various experiences inform different views as to the best course of action to take.  Luckily, though, directors’ duties can lessen the likelihood of those conflicts becoming unresolvable.  Directors’ duties create an objective standard, against which the merit of all directorial conduct is measurable.  That standard is simple: is a proposition in the best interests of the company? There will be times when directors disagree, but if they remain focused on that question, as they are duty-bound to, then the chances of amiable resolution are higher.

If you want to ensure compliance with your duties as a director, some legal guidance will be helpful.  Similarly, if you’re facing a seemingly insurmountable conflict between directors, some objective advice could be handy.  Contact me for informed and experienced advice.