Direction for Directors
Companies in Australia are incorporated under the Corporations Act 2001 (Cth) (“the Act”). Once incorporated, companies have their own “legal personality”, and are able to own property and enter into commercial transactions in their own right. When the people in charge of managing a company (directors) act on the company’s behalf, and something goes wrong, it is the company (and the company’s assets), and not the individual directors, who can be held responsible for righting that wrong.
This liability (and asset) protection for individual directors is often referred to as “the corporate veil”, and is one of the key reasons that people establish companies to transact through, rather than doing so as an individual.
It is vital for directors to understand the circumstances in which the corporate veil can be “pierced”, enabling a wronged party to reach beyond the company assets, and attack a director personally. Further, a lack of understanding of the legal responsibilities carried by directors can have major repercussions not only for individual directors, but also for the company and its shareholders.
Director’s duties: The duties imposed on company directors, which are intended to prevent the misuse (or abuse) of power, and to ensure proper accountability, are set out in sections 180 to 184 of the Act.
Directors have duties to:
The purpose of the director’s duties is to balance directors’ accountability to the interests of the company and its shareholders, whilst allowing discretion to make decisions that involve a degree of risk.
Whether an act by a director is in breach of their duties is determined objectively. Generally, the applicable test is whether that Director acted “in [a] way that no rational director would have considered to be in the company’s best interest” (see ASIC v Adler (2002) 42 ACSR 72).
The Australian Securities and Investments Commission (ASIC) is the body responsible for enforcing director’s duties.
Who are the duties owed to? Director’s duties are primarily owed to the company. However, directors must also be conscious that their obligations can extend to the company’s wider stakeholders, including:
Directors should always be mindful of their duties and obligations when entering into dealings as a representative of the company.
“Care and diligence”: Acting with proper care and diligence requires directors to have regard to, and insight into, the company’s activities, size, functions, and financial position. This usually requires directors to ensure that, where they are disclosing company information to a third party, the information being disclosed is complete and accurate. The duty also extends to directors making business decisions in the operation of the company.
In making business decisions, a director will have acted with proper care and diligence where:
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The well-publicised collapse of Storm Financial Limited (“Storm”) as a consequence of the 2007-2009 Global Financial Crisis resulted in significant losses for investors, and caused ASIC to bring civil proceedings against Storm founders Emmanuel and Julie Cassimatis (Australian Securities and Investment Commission (ASIC) v Cassimatis (No. 8) [2016] FCA 1023) for breaching their duty to act with care and diligence.
The model that Storm pitched to its investors encouraged, strongly, those investors to secure loans against their homes to obtain funds to invest with Storm (and to pay Storm’s not insignificant fees), in what it described as a “reliable”, and low or “manageable” risk, form of investment. This model, developed by Mr Cassimatis, was applied to all of Storm’s clients. When the financial services industry collapsed, many of Storm’s clients defaulted on their home loans. Mr and Mrs Cassimatis’ submitted that the Storm model was economically viable, and not so irresponsible to be a breach of their duty to act with care and diligence.
Whilst the Court did not disagree with their argument in principle, it held that Mr and Mrs Cassimatis’ breached their duty because the Storm model – described as particularly “aggressive” – was “flawed and inappropriate” to the extent that it was applied universally to all clients. This included investors who were “financially vulnerable” (specifically, those who were retired (or near retired), had few assets, and had limited income).
The Court held that Mr and Mrs Cassimatis each exercised their powers as directors “in a way which caused or “permitted” (by omission to prevent) inappropriate advice to be given to the relevant investors”. After an unsuccessful appeal, they were ultimately fined $70,000.00 each, and disqualified from managing companies for seven years.
Act in “good faith” and for a “proper purpose”: “Good faith” requires directors to act not only in the interests of the company (and its stakeholders), but also to act “for a proper purpose” in their dealings on the company’s behalf.
Breaching director’s duties can expose a director not only to civil liabilities, but also – where they act in a way that is “reckless” or “dishonest” – criminal penalties! R v Byrnes and Hopwood (1995) 183 CLR 501 concerned criminal liability for two directors’ actions. In order to raise capital, a company resolved to issue credit notes to its shareholders. Unbeknownst to the company’s board, two directors entered into an agreement with an underwriter, who would lend the company the amount of any shortfall funds. Although the directors were acting in a way that they thought (hoped) would be of benefit to the company, their actions in concealing the underwriting agreement (not only from the board, but from a prospective purchaser of the company), were not done in good faith, and exposed them to criminal penalties.
Proper use of power: A company representative must not improperly use their position to gain a personal financial advantage, or cause detriment to company. This applies not only to directors, but other company officers (secretaries who are not directors, for example) and relevant employees.
Another well-known example of piercing the corporate veil is the case of Rodney Adler and HIH Insurance (“HIH”). In June 2000, HIH provided an unsecured and undocumented $10 million loan to a unit trust controlled by Mr Adler, who was at the time a director of HIH.
HIH’s shareholders were not asked to approve the loan of funds to Mr Adler’s unit trust. Nor was the transaction on arms-length commercial terms. Mr Adler received a personal benefit (estimated at around $2M) from this transaction, and HIH ultimately collapsed in 2001 with debts of $5.3B.
ASIC v Adler (2002) 42 ACSR 72 is particularly famous because, for his role in the transaction, Mr Adler was found to have not only breached his director’s duties, but to have done so in a way that attracted criminal penalties. Mr Adler was sentenced to 4 years and 6 months in prison.
Use of company information: A director (or other representative) must not use company information to gain an advantage for themselves (or another) or to cause detriment to the company. Importantly, this duty persists even after the director ceases to be a representative of that company.
In Lifeplan Australia Friendly Society Ltd v Ancient Order of Foresters in Victoria Friendly Society Limited [2017] FCAFC 74, two senior employees of Lifeplan Australia Friendly Society Ltd (“Lifeplan”) moved their employment to a competitor, Ancient Order of Foresters in Victoria Friendly Society Limited (“Foresters”). As part of their transition, they attempted to bring Lifeplan’s clients with them, and used confidential Lifeplan documents, and information from Lifeplan’s client database, to contact and attract clients to change their provider to Foresters.
The Court found that not only did the employees dishonestly breach their duties to Lifeplan, but that Foresters knowingly assisted them to do so. Foresters was ordered to account to Lifeplan for their profits, which amounted to $6,558,495 plus interest.
How Can We Help? WMM Law has specialist skills and experience to assist in company and director matters, including incorporating new companies, and advising companies (and individual directors) in commercial transactions. Please contact Kimberley Martin, David Bailey, Casey Goodman or Jock Denehey if you, or anyone you know, need expert advice and guidance about these matters.