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Directors owe duties to the company to act in the interests of the company in order to promote good governance. However, sometimes directors breach their duties by engaging in phoenix activities (transferring assets of an indebted company to a new company).
A. Directors’ Duties under General Law
Six main types of directors’ duties could be identified under General Law or Common Law. They are as follows:
- Duty to act bona fide (in good faith) in the interests of the company as a whole: Good faith contains both subjective and objective elements, in that a director must genuinely believe that they are acting in the company’s best interests and must also in a way that an honest and reasonable director would act.
- Duty to exercise powers for a proper purpose: Directors must exercise their corporate powers for the purposes for which they were granted the position of director.
- Duties of care and diligence: Directors have a duty to be informed on the financial affairs of their company and to make an informed and independent judgment on the decisions put to the directors and to place themselves in a position to guide the company and monitor its management.
- Duty not to fetter own future discretion: Directors must exercise active discretions and not improperly place constraints upon the exercise of their directorial discretions so as to ensure that they are not limited from acting in the best interests of the company.
- Duty to avoid conflicts of interest: Directors must avoid conflicts of interest and disclose and manage conflicts if they arise. If a director must choose between favouring his or her own interests and the interests of the company, the director must usually choose the latter course.
- Duty not to make secret profits: Directors have a duty to account to the company for any profit that he or she makes in connection with his or her office without the company’s fully informed consent
B. Directors’ Duties under the Corporations Act 2001 (Cth)
The main legislative directors’ duties are contained in the Corporations Act 2001 (Cth) and they are as follows:
Section 180(1): Directors must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise. Reasonable person indicates an objective standard of care, consistent with the development of the equivalent fiduciary duty. Reasonable degree of care and diligence requires a balancing act of the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to company from the conduct in question.
Section 180(2): The business judgment rule provides the director must:
- Make their judgment in good faith for a proper purpose;
- 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 that they reasonably believe to be appropriate; and
- Rationally believe that the judgment is in the best interests of the corporation.
The business judgement rule is an overriding safe harbour to protect directors from personal liability for breaches of duty owed to the company. The director must satisfy these requirements in order to have been taken to have satisfied the statutory duty of care and diligence.
Business judgment is defined in Section 180(3) as any decision to take or not take action in respect of a matter relevant to the business operations of the corporation. The rule applies only to business judgments consciously made, failures to act or omissions are not protected.
Section 181: Directors must exercise their powers and discharge their duties in good faith in the best interests of the corporation and for a proper purpose. This means directors must exercise their powers bona fide for the benefit of the company.
Section 182: Directors must not improperly use their position to gain an advantage for themselves or someone else, or cause detriment to the corporation, regardless of whether the benefit or detriment actually occurs in fact.
Section 183: Directors must not improperly use the information obtained as a director of the company to gain an advantage for themselves or someone else, or cause detriment to the corporation, despite of what actually occurs in fact.
Section 191: Directors have a duty to disclose to other directors any material personal interest in matters that relate to the affairs of the company.
Section 588G: Directors have a duty to prevent insolvent trading of a company. Please refer to our article on “Director’s Duty to Prevent Insolvent Trading”.
C. Phoenix Activities
Illegal phoenix activity involves the intentional transfer of assets from an indebted company to a new company to avoid paying creditors, tax or employee entitlements, thereby the new company arises from the ashes of a failed predecessor. The directors leave the debts with the old company, often placing that company into administration or liquidation, leaving no assets to pay creditors. Figures put the cost of illegal phoenix activity to the Australian economy at potentially more than $3 billion annually.
The Australian Securities & Investments Commission defines phoenix activities as those when a company:
- Fails and is unable to pay its debts; and/or
- Acts in a manner which intentionally denies unsecured creditors equal access to the available assets in order to meet and pay debts; and
- Within 12 months of closing another business commences which may use some or all of the assets of the former business, and is controlled by parties related to either the management or directors of the previous company.
The particular duties a director conducting phoenix activities is likely to contravene include the duty to act in good faith and the duties in relation to proper use of information and position.
Specific remedies available against directors who engage in phoenix activity include civil and criminal penalties under the Corporations Act, disqualification of rogue directors, and access by creditors to directors’ personal assets and the prevention and recovery of asset transfers. However, most of these protections are remedial action conducted well after the damage has been done, providing little prevention or deterrence for directors from engaging in phoenix activity.
Preventative measures could be taken when dealing with rogue directors who may become involved in phoenix activities. Comasters Law Firm could advise you on these measures.
© Comasters May 2014.
Important: This is not advice. Clients should not act solely on the basis of the material contained in this paper. Our formal advice should be sought before acting on any aspect of the above information.