Directors' duties are a series of statutory, common law and equitable obligations owed primarily by members of the board of directors to the corporation that employs them. It is a central part of corporate law and corporate governance. Directors' duties are analogous to duties owed by trustees to beneficiaries, and by agents to principals.
Among different jurisdictions, a number of similarities between the framework for directors' duties exist.
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Directors have Fiduciary Duties under general law in Australia. They are:
Directors also have duties under Corporations Act 2001:
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Directors are also strictly charged to exercise their powers only for a proper purpose. For instance, were a director to issue a large number of new shares, not for the purposes of raising capital but to defeat a potential takeover bid, that would be an improper purpose.[5]
However, in many jurisdictions the members of the company are permitted to ratify transactions that would otherwise fall foul of this principle. It is also largely accepted in most jurisdictions that this principle should be capable of being abrogated in the company's constitution.
Directors must exercise their powers for a proper purpose. While in many instances an improper purpose is readily evident, such as a director looking to feather his or her own nest or divert an investment opportunity to a relative, such breaches usually involve a breach of the director's duty to act in good faith. Greater difficulties arise where the director, while acting in good faith, is serving a purpose that is not regarded by the law as proper.
The seminal authority in relation to what amounts to a proper purpose is the Privy Council decision of Howard Smith Ltd v. Ampol Ltd.[6] The case concerned the power of the directors to issue new shares.[7] It was alleged that the directors had issued a large number of new shares purely to deprive a particular shareholder of his voting majority. The court rejected an argument that the power to issue shares could only be properly exercised to raise new capital as too narrow, and held that it would be a proper exercise of the director's powers to issue shares to a larger company to ensure the financial stability of the company, or as part of an agreement to exploit mineral rights owned by the company.[8] If so, an incidental result (even desirable) that a shareholder lost his majority, or a takeover bid was defeated would not itself make the share issue improper. But if the sole purpose was to destroy a voting majority, or block a takeover bid, that would be an improper purpose.
Not all jurisdictions recognised the "proper purpose" duty as separate from the "good faith" duty however.[9]
This represents a considerable departure from the traditional notion that directors' duties are owed only to the company. Previously in the United Kingdom, under the Companies Act 1985, protections for non-member stakeholders were considerably more limited (see e.g., s.309, which permitted directors to take into account the interests of employees but that could be enforced only by the shareholders, and not by the employees themselves. The changes have therefore been the subject of some criticism.[10] Directors must act honestly and in bona fide. The test is a subjective one—the directors must act in "good faith in what they consider—not what the court may consider—is in the interests of the company..."[11] However, the directors may still be held to have failed in this duty where they fail to direct their minds to the question of whether in fact a transaction was in the best interests of the company.[12]
Difficult questions arise when treating the company too abstractly. For example, it may benefit a corporate group as a whole for a company to guarantee the debts of a "sister" company,[13] even if there is no "benefit" to the company giving the guarantee. Similarly, conceptually at least, there is no benefit to a company in returning profits to shareholders by way of dividend. However, the more pragmatic approach illustrated in the Australian case of Mills v. Mills (1938) 60 CLR 150 normally prevails:
"[directors are] not required by the law to live in an unreal region of detached altruism and to act in the vague mood of ideal abstraction from obvious facts which [sic] must be present to the mind of any honest and intelligent man when he exercises his powers as a director."
"money which [sic] is not theirs but the company’s, if they are spending it for the purposes which are reasonably incidental to the carrying on of the business of the company. That is the general doctrine. Bona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying away its money with both hands in a manner perfectly bona fide yet perfectly irrational… It is for the directors to judge, provided it is a matter which is reasonably incidental to the carrying on of the business of the company… The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company."
Directors cannot, without the consent of the company, fetter their discretion in relation to the exercise of their powers, and cannot bind themselves to vote in a particular way at future board meetings.[14] This is so even if there is no improper motive or purpose, and no personal advantage to the director.
This does not mean, however, that the board cannot agree to the company entering into a contract that binds the company to a certain course, even if certain actions in that course will require further board approval. The company remains bound, but the directors retain the discretion to vote against taking the future actions (although that may involve a breach by the company of the contract that the board previously approved).
Traditionally, the level of care and skill a director must demonstrate has been framed largely with reference to the non-executive director. In Re City Equitable Fire Insurance Co [1925] Ch 407, it was expressed in purely subjective terms, where the court held that:
However, this decision was based firmly in the older notions (see above) that prevailed at the time as to the mode of corporate decision making, and effective control residing in the shareholders; if they elected and put up with an incompetent decision maker, they should not have recourse to complain.
However, a more modern approach has since developed, and in Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 the court held that the rule in Equitable Fire related only to skill, and not to diligence. With respect to diligence, what was required was:
This was a dual subjective and objective test, and one deliberately pitched at a higher level.
More recently, it has been suggested that both the tests of skill and diligence should be assessed objectively and subjectively; in the United Kingdom the statutory provisions relating to directors' duties in the new Companies Act 2006 have been codified on this basis.[15]
Directors also owe strict duties not to permit any conflict of interest or conflict with their duty to act in the best interests of the company. This rule is so strictly enforced that, even where the conflict of interest or conflict of duty is purely hypothetical, the directors can be forced to disgorge all personal gains arising from it. In Aberdeen Ry v. Blaikie (1854) 1 Macq HL 461 Lord Cranworth stated in his judgment that,
"A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into..."
"A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into..."
As fiduciaries, the directors may not put themselves in a position where their interests and duties conflict with the duties that they owe to the company. The law takes the view that good faith must not only be done, but must be manifestly seen to be done, and zealously patrols the conduct of directors in this regard; and will not allow directors to escape liability by asserting that his decision was in fact well founded. Traditionally, the law has divided conflicts of duty and interest into three sub-categories.
By definition, where a director enters into a transaction with a company, there is a conflict between the director's interest (to do well for himself out of the transaction) and his duty to the company (to ensure that the company gets as much as it can out of the transaction). This rule is so strictly enforced that, even where the conflict of interest or conflict of duty is purely hypothetical, the directors can be forced to disgorge all personal gains arising from it. In Aberdeen Ry v. Blaikie[16] Lord Cranworth stated in his judgment that:
"A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into..."
However, in many jurisdictions the members of the company are permitted to ratify transactions which would otherwise fall foul of this principle. It is also largely accepted in most jurisdictions that this principle should be capable of being abrogated in the company's constitution.
In many countries there is also a statutory duty to declare interests in relation to any transactions, and the director can be fined for failing to make disclosure.[17]
Directors must not, without the informed consent of the company, use for their own profit the company's assets, opportunities, or information. This prohibition is much less flexible than the prohibition against the transactions with the company, and attempts to circumvent it using provisions in the articles have met with limited success.
In Regal (Hastings) Ltd v Gulliver [1942] All ER 378 the House of Lords, in upholding what was regarded as a wholly unmeritorious claim by the shareholders,[18] held that:
And accordingly, the directors were required to disgorge the profits that they made, and the shareholders received their windfall.
The decision has been followed in several subsequent cases,[19] and is now regarded as settled law.
Directors cannot, clearly, compete directly with the company without a conflict of interests arising. Similarly, they should not act as directors of competing companies, as their duties to each company would then conflict with each other.
As in most jurisdictions, the law provides for a variety of remedies in the event of a breach by the directors of their duties: