Company directors have a responsibility to act in the best interests of the company. If you take on the role of company director without being aware of this responsibility, you could let yourself in for a lot of trouble. In this guide we will cover the main responsibilities of a company director.
In Australia, the responsibilities of company directors are set out in the Corporations Act 2001 which we review in high detail below.
What is the Role of the Director?
A company director is part of a board of directors. As a member of the board, they are expected to set the direction and strategy for the company, appoint the chief executive, set and approve policies, approve budgets and monitor the performance of the company. It is an interesting and challenging role.
There are also specialised roles for Board members. The Chairman leads the board and often works most closely with the senior management in the company. The secretary is responsible for running the board including setting meeting times and ensuring that minutes are recorded and distributed. The board will often also have subcommittees that handle parts of the workload. For example, there is often an audit committee and a finance committee.
It is worth distinguishing between an executive director and a non-executive director. An executive director is also an executive of the company while a non-executive director comes from outside the company.
What are the Company’s Best Interests?
The company’s best interests will vary as the company develops, technology changes and the markets in which it operates change. However, the company’s best interests are usually considered to be the same as the shareholders’ or members’ long term interests. So, the company director should act to promote the long term prosperity and growth of the company.
There are some exceptions to this. When a company is in trouble the director may have to consider the best interests of the creditors. Company directors do not need to consider employees’ interests, but they do need to make sure that the company meets it obligations to its employees.
Four Main Responsibilities for Directors
The Corporations Act 2001 lays out four responsibilities for a company director. These include:
- A duty to act with care and diligence
- A duty to act in good faith
- A duty not improperly use position
- A duty to not improperly use information.
We will look at the first two in more detail. The last two are more straightforward. The director must not use their position or the information they gain through their position to advantage themselves or someone else. As well they must not use their position of the information gained through that position to harm the company.
The Duty to Act with Care and Diligence
The Act requires that the company director carries out their duties with care and diligence. While this sounds very open, it actually means that the director should do their work with the same degree and care that a reasonable person with the appropriate level of skills and experience expected from a director would do their work. This sets a high standard for a director to follow.
Directors are expected to have the skills and knowledge to guide the company. For example, a director when accused of not taking proper oversight of the company’s financial position would not be able to use as an excuse that they could not follow the company accounts. But alternatively, a non-executive director would not be expected to have as detailed an insight into the operations of the company as an executive director.
A Duty to Act in Good Faith
- This duty requires that a company director takes steps to disclose any actual or potential conflict of interest. A conflict of interest occurs when the director’s personal interests or duties could conflict with the interests of the company. The director is required to disclose the actual or potential conflict of interest as soon as they become aware of it. The usual procedure is for that director to absent themselves from and discussion or decision making on the matter.
Duty of Preventing Insolvent Trading
As well as the four duties laid out above the Act, places some other obligations on company directors.
- The most significant of these is around insolvent trading. All directors are required to prevent the company being in a position where it is not able to pay its debts. In other words, does the company have enough cash and assets that can be converted into cash to meet its current and future liabilities.
- As soon as the director is aware that company is either insolvent or about to become insolvent, they have an obligation to stop the company from trading.
- If a director fails in this duty they may become liable for the amount loss either by the company or its creditors.
There are some accepted defences that company directors can use if something goes wrong. In the case of the duty of care and diligence, a director who has made a `business judgement’ in good faith after considering all the relevant material, where they have no personal interest in the decision and where they believe that the decision is in the best interests of the company are generally protected from prosecution.
- In the case of the company becoming insolvent, the defence rests on the whether the company director reasonably believed that the company was solvent or that the director took all reasonable steps to prevent the company becoming insolvent. Alternatively the director who took no part in management of the company due to illness is also protected. Also, as of 19 September 2017, the Corporations Act provides directors with a safe harbour for insolvent trading. This allows the company to trade out of its insolvent position under certain conditions.
Sanctions for Breaking the Laws Covering Director’s Duties
Under Australian law, a director who fails in their duties can be fined or subjected to other civil and criminal penalties.
The civil sanctions include fines up to $1.05 million or thrice the benefit acquired from the breach of their duties. In addition, shareholders or creditors can sue the director.
If the breach was intentional and dishonest, the director can also become liable to criminal penalties. The penalties start with fines and move up to five or ten years in prison.
A director who fails in their duties will almost certainly be removed from their position and may be disqualified from serving as a company director for a long period of time.
Some organisations will provide their directors with insurance. This can help in some cases but does not cover dishonest behaviour.
Being a Company director while interesting and challenging requires people to take their responsibilities seriously. Failure can lead to severe penalties hence why it is vital to get acquainted with your obligations as imposed under the Corporations Act.
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