RESEARCH PAPER SERIES, 2021–22   17 June 2022

Directors Duties: a quick guide

Paula Pyburne and Jaan Murphy

Law and Bills Digest Section

1 Background

Australian law imposes numerous duties and obligations upon various people who are employed by, or who act on behalf of, an Australian company. The particular duties depend upon the role of the person within the company. The Corporations Act 2001 sets out the rules for the formation and registration of companies in Australia and provides that there may be directors, members and officers of a company.

The Corporations Act requires that a proprietary company have at least one director and that person must ordinarily reside in Australia [subsection 201A(1)]. A public company must have at least three directors, two of whom must ordinarily reside in Australia [subsection 201A(2)].

1 Nature of the duties

Part 2D.1 of the Corporations Act sets out the statutory duties and powers of directors and officers of corporations. A corporation is:

• a company

• any body corporate (whether incorporated in this jurisdiction or elsewhere)

• an unincorporated body that under the law of its place of origin, may sue or be sued, or may hold property in the name of its secretary or of an office holder of the body duly appointed for that purpose and

• includes an Aboriginal and Torres Strait Islander corporation that has been incorporated under the Corporations (Aboriginal and Torres Strait Islander) Act 2006 [section 57A].

The relevant duties are set out below.

Duty to exercise reasonable care and diligence

First, a director, or other officer, of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were a director or officer of a corporation in the corporation’s circumstances; and occupied the office held by, and had the same responsibilities within the corporation, as the director or officer [subsection 180(1)].

A director, or other officer, of a corporation who makes a business judgment is taken to satisfy the duty (and their equivalent duties at common law and in equity) in respect of the judgment if they do all of the following:

• make the judgment in good faith for a proper purpose

• do not have a material personal interest in the subject matter of the judgment

• inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate and

• rationally believe that the judgment is in the best interests of the corporation [subsection 180(2)].

At first glance, this would appear to provide a presumption in favour of directors. However, since the decision of Austin J in Australian Securities and Investments Commission v Rich at [7269] [Duty of Care and Diligence and the Business Judgment Rule], it has been generally accepted that the business judgement rule operates only as a defence—casting the onus on the director to defend his, or her, decision-making [pp. 15–16].

This is a civil penalty provision. A breach of this duty will not give rise to a criminal offence.

Duty to act in good faith

Second, a director or other officer of a corporation must exercise their powers and discharge their duties in good faith in the best interests of the corporation and for a proper purpose [section 181]. This is a civil penalty provision.

In the case of Australian Securities and Investments Commission v Maxwell Brereton J emphasised that section 181 is not concerned with the conduct of a director in relation to creditors, other persons dealing with or concerned with the company, or anybody else but the company itself; and that a breach of the obligation to act bona fide in the interests of the company involves a consciousness that what is being done is not in the interests of the company, and deliberate conduct in disregard of that knowledge at [107–110].

In addition, the Corporations Act creates a criminal offence in equivalent circumstances to section 181 [subsection 184(1)]. The fault elements of the offence are dishonesty and intention; and dishonesty and recklessness. The penalty is a maximum of 15 years imprisonment [Schedule 3].

Duty not to improperly use position/information

Third, a director, secretary, other officer or employee of a corporation must not improperly use their position to gain an advantage for themselves or someone else; or cause detriment to the corporation [section 182].

Fourth, and in similar terms, a person who obtains information because they are, or have been, a director or other officer or employee of a corporation must not improperly use the information to gain an advantage for themselves or someone else; or cause detriment to the corporation [section 183].

Each of these duties is a civil penalty provision. In addition, the Corporations Act creates criminal offences in equivalent circumstances. The fault elements of the offences are intention and recklessness [subsections 184(2) and 184(3)]. The penalty for a criminal offence in respect of each of the duties is a maximum of 15 years imprisonment [Schedule 3].

Importantly, it is not a defence in a court proceeding for an offence in relation to these duties that the person uses their position or information with the result of, or with the intention of, gaining an advantage for the corporation [subsections 184(2A) and 184(4)].

2 Breach of the duties

Breach of a civil penalty provision

An action against a person for a breach of a civil penalty provision is made by application from the Australian Securities and Investments Commission (ASIC) to the relevant Court [section 1317J]. If the Court is satisfied that the breach of directors’ duties is a contravention of a corporation/scheme civil penalty provision, the Court must issue a certificate of declaration to that effect [section 1317E].

Order for pecuniary penalty

Once the Court has issued a certificate of declaration that the duty has been breached, it may order the payment of a pecuniary penalty if the contravention:

• materially prejudices the interests of the corporation … or its members

• materially prejudices the corporation’s ability to pay its creditors or

• is serious [paragraphs 1317G(1)(a) and (b)].

The amount of the pecuniary penalty to be paid by an individual is the greater of 5,000 penalty units (currently equivalent to $1,110,000) and, if the Court can determine the benefit derived and detriment avoided because of the contravention—that amount multiplied by three [subsection 1317G(3)]. However, the amount is capped and cannot exceed the pecuniary penalty otherwise payable for the contravention of the civil penalty provision [subsection 1317G(2)].

In determining the amount of the pecuniary penalty, the Court must take into account a range of relevant matters, including, but not limited to, the nature and extent of the contravention, the circumstances in which the contravention took place and whether the person has previously been found by a court (including a court in a foreign country) to have engaged in similar conduct [subsection 1317G(6)].

A pecuniary penalty is a debt payable to ASIC on behalf of the Commonwealth [section 1317GAA].

Make a relinquishment order

A relinquishment order aims to neutralise any financial benefit that might have been gained from the relevant misconduct [page 57].

That being the case, the relevant Court can make a relinquishment order on its own initiative during proceedings before the Court, or on application from ASIC [subsection 1317GAB(2)]. The amount to be paid under the order is equal to the benefit derived and detriment avoided—that is, the sum of the total value of all benefits obtained by one or more persons that are reasonably attributable to the contravention, and the total value of all detriments avoided by one or more persons that are reasonably attributable to the contravention [section 1317GAD].

Make a compensation order

Further, a Court may order a person (including a director) to compensate a corporation, registered scheme or notified foreign passport fund for damage suffered by the corporation, scheme or fund if the person has contravened a corporation/scheme civil penalty provision (that is, directors’ duties) and the damage resulted from the contravention [subsection 1317H(1)].

Criminal offences

A person who does an act or thing that the person is prohibited from doing under a provision of the Corporations Act or does not do an act or thing that the person is required or directed to do by a provision of the Corporations Act is guilty of a criminal offence [section 1311]. An offence is punishable by the criminal sanctions of imprisonment or fine [section 1311B].

The Criminal Code Act 1995 contains the Criminal Code (the Criminal Code). Chapter 2 of the Criminal Code comprises a comprehensive statement of principles of criminal responsibility for Commonwealth offences which applies to all Corporations Act offences [section 1308A]. The Criminal Code provides that offences have physical elements, for example, doing or not doing an action, and fault elements, such as intention, knowledge, recklessness or negligence [section 3.1].

What is recklessness?

According to the Criminal Code a person is reckless with respect to a circumstance if he, or she, is aware of a substantial risk that the circumstance exists or will exist; and having regard to the circumstances known to him, or her, it is unjustifiable to take the risk. Similarly, a person is reckless with respect to a result if he, or she, is aware of a substantial risk that the result will occur; and having regard to the circumstances known to him or her, it is unjustifiable to take the risk [section 5.4].

What is a proper purpose?

Where directors engage in intentional acts that would amount to unlawful conduct, they are likely to breach their duties. As noted by the Federal Court of Australia in Australian Securities and Investments Commission v Cassimatis (No 8) (the Storm Financial case):

A corporation has a real and substantial interest in the lawful or legitimate conduct of its activity independently of whether the illegitimacy of that conduct will be detected or would cause loss … it would be hard to imagine examples where it could be in a corporation’s interests for the corporation to engage in serious unlawful conduct even if that serious unlawful conduct was highly profitable and was reasonably considered by the director to be virtually undetectable during a limitation period for liability (at [482]).

Critically this means that where a director has facilitated a corporation engaging in an illegal activity it will be difficult (if not impossible) for the director to prove that they acted for a proper purpose.

3 Consequences of a breach of duties

Disqualification

The Corporations Act provides that a person is automatically disqualified from managing a corporation in certain circumstances. In particular, if a person is convicted of an offence under the Corporations Act that is a breach of directors’ duties (other than the duty to exercise reasonable care and diligence which is only a civil penalty provision) the disqualification provision will apply [subparagraph 206B(1)(b)(i)]. The period of disqualification is five years [subsection 206B(2)]. The disqualification may be extended by the Court on application by ASIC for up to an additional 15 years [subsections 206BA(2) and (3)]. In determining whether an extension is justified (and if so, for how long), the Court may have regard to any matters that the Court considers appropriate [subsection 206BA(5)].

A person who breaches the first directors’ duty—the duty to exercise reasonable care and diligence—may also be disqualified from managing a corporation. However, the disqualification is not automatic. ASIC may apply to the Court for a disqualification order once a certificate of declaration is made. It is for the Court to determine whether disqualification is justified, and if so, the period of disqualification [section 206C].

Other remedies

Questions about whether directors have complied with their duties will often arise in the context of the administration or liquidation of a company—particularly if there have been allegations that the company was subject to ‘phoenixing’.

It is important to note that the Corporations Act contains significant penalties for breaches of other requirements which are separate from directors’ duties—but which may impose obligations on directors outside of the directors’ duties outlined in Part 2D.1. Where the evidence is insufficient to prove a breach of directors’ duties it may be that the relevant conduct contravenes another provision of the Corporations Act (for instance a failure to keep financial records or a director’s duty to prevent creditor-defeating dispositions in the context of insolvency).

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