Directors have a number of obligations under the Corporations Act 2001 (Cth). Failure to meet those obligations may result in exposure to claims for breach of duty.
In this article, we provide a brief explanation of the key duties imposed on directors, and how directors can effectively discharge their duties.
Directors must be aware of their duties under the Corporations Act 2001 (Cth) (the Act) and act accordingly, as failure to do so may expose a director to personal liability.
Directors are responsible for achieving the efficient conduct of the company's business and adopting a critical and enquiring mindset.
Directors must stay informed of the financial affairs of the company, including its solvency. This duty cannot be delegated, and no defence exists for wilful blindness.
Directors have several key duties, including the duty to:
exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise;
exercise their powers and discharge their duties in good faith in the best interests of the company, and for a proper purpose;
not improperly use their position to gain an advantage for themselves or someone else, or cause detriment to the company;
not use information improperly that was obtained whilst a director; and
prevent the company engaging in insolvent trading.
Importantly, the duties imposed on directors are broadly the same, regardless of whether you are a director of a small to medium enterprise (SME), a self-managed super fund (SMSF) or a company listed on the ASX.
How can directors effectively discharge their duties?
To avoid exposure to a claim for breach of duties, there are several steps a directors can take. These include exercising due care and skill in decision making, and ensuring that the company has sound corporate governance practices in place.
We set out in detail below the practical strategies that a director may wish to adopt to ensure compliance with their duties.
Monitor the company's financial position and operations
Directors are expected to maintain familiarity with the financial status of the company and have a rudimentary understanding of the company's activities.
Whilst there is no obligation for directors to attend all board meetings, directors should regularly attend board meetings, be engaged, and allow sufficient time to discuss matters.
Apply an inquiring mind
Though directors are not required to oversee every detail of management or scrutinize information in great detail, directors should take a diligent interest in the information available to them.
Where board papers appear inconsistent with the knowledge of the company's affairs held by the director, directors should act proactively and draw this to the attention of the board. Similarly, if board papers omit or fail to effectively disclose any matters known to the director, this should also be raised.
To avoid the risk of breach, directors should exercise caution in "red flag" situations, such as major company transactions, capital raisings and disclosure, and transactions that raise related party issues.
In order to make decisions that are informed and based on independent judgments, directors should also make sure that concise board papers are prepared containing all necessary information to make such decisions.
Maintain financial literacy
To effectively fulfil their legal duties and obligations, particularly in regards to assessing solvency, it is recommended that directors undertake professional development to maintain financial literacy.
As directors often make decisions which affect the financial health of a company, directors must have a sufficient understanding of:
the factors that may indicate insolvency;
financial assessments required in funding and capital decisions; and
key financial reporting standards.
Implement sound corporate governance processes
In order to reduce the risk of a company breaching any of its liabilities, it is up to directors to ensure that appropriate controls and protocols are in place. This entails checking that the company has implemented an effective board briefing process to support and record decision-making.
In participating in board meetings, directors ought to ensure that the minutes adequately record the reasons for board decisions and reflect discussion by the board, as board minutes indicate that independent judgment was exercised by directors.
Obtain external advice
Directors may wish to obtain professional advice and assistance relating to their duties as a director.
By way of example, directors may engage an accountant to assist in the preparation or review of financial statements, as this may aid directors in providing an independent view.
Whilst the law recognizes that directors may need to rely on appropriate advice received from others, directors should apply a degree of scrutiny to that advice to properly discharge their duties.
Importantly, the presence of independent advice may assist directors if any assertion is made that a director has failed to adequately perform their duties.
Continually assess solvency
To ensure that a company stays afloat, directors must ensure that there is a reasonable basis for an expectation that the company is solvent.
Directors must confirm the availability of reliable financial statements and regularly review cash flow forecasts. If the circumstances indicate a need to make further enquiries as to the financial statements, directors should also proceed to do so.
If more information is needed to make an informed decision, directors should seek advice from an insolvency practitioner in a timely manner and familiarise themselves with the company's restructuring options.
Common mistakes made by directors of SMEs
Many SME directors are unaware of how the Act applies to them and the nature of their duties under the Act. Such directors also lack awareness of the extent of their personal liability for breaching their duties as a director.
In particular, small family companies often lack clearly defined roles and responsibilities, and become vulnerable to financial trouble. Whilst it is common that directors of small family companies are also shareholders, it is vital that such directors understand the importance of acting in the best interests of the company in the decision making process, as opposed to themselves.
It is also common for the appointment of both spouses as directors of small family companies, with one spouse left responsible for managing the financial affairs of the company. This arrangement, based on a high degree of trust, prevents the other spouse from arguing a lack of liability for breach of director's duties where the director responsible fails to acquaint themselves with all company matters.
To avoid the risk of personal liability, it is vital that directors of SMEs and small family companies undertake their duties in a timely manner to prevent financial strife.
Consequences for failing to abide by director duties
Increasingly, directors are being exposed to personal liability for breaching their directors' duties. Any contravention of a director's duties may result in a director being required to compensate for damages incurred as a consequence of the contravention, or account for all profits made.
If the breach is committed by a director with recklessness or dishonest intent, this constitutes a criminal offence and may subject a director to a substantial monetary penalty and/or imprisonment.
Directors are now under significant pressure to perform their duties with utmost care. In order to discharge their duties, directors must guide and monitor the management of the company, or risk facing considerable criminal and/or civil penalties.
This information is provided solely for general information purposes and is not intended as professional advice. Readers should not act on the information contained therein without proper advice from a suitably qualified professional.
We expressly disclaim all liability for any loss or damage to any person or organisation for the consequences of anything done or omitted to be done by any such person relying on the contents of this information.