The recent slew of high profile cases involving directors of failed finance companies highlights the need for all current and would-be directors to understand and sufficiently perform their directors’ duties. This article provides a snapshot of directors’ duties under the Companies Act 1993 (the “Act“) and a practical guide on how these can be satisfied.
Your directors’ duties under the Act
The business and affairs of a company must be managed by, or under the direction or supervision of, the board of directors of the company. In addition to this primary duty, directors also have the following core duties:
- to act in good faith and in the company’s best interests;
- to exercise due care, diligence and skill;
- to exercise powers for a proper purpose;
- to comply with the Act and with the company’s constitution;
- to avoid carrying on the business of the company in a manner likely to create a substantial risk of serious loss to the company’s creditors; and
- to avoid incurring obligations unless satisfied that the company will be able to honour them when required to do so.
In addition to penalties imposed by the Act for breaches of specific obligations, if the company goes into liquidation and a director is found to be in breach of his or her directors’ duties, that director could be held personally liable to repay or restore funds (with interest), or to contribute a sum to the assets of the company. Furthermore, the recently introduced Companies and Limited Partnerships Amendment Bill aims to criminalise breaches of:
- the duty to act in good faith and in the company’s best interests, if the director knows that the breach is seriously detrimental to the interests of the company; and
- the duty to avoid carrying on the business of the company in a manner likely to create a substantial risk of serious loss to the company’s creditors, if the director knows that the breach will result in serious loss to the company’s creditors.
Should this bill proceed without amendment, the maximum penalty will be 5 years’ imprisonment or a fine of $200,000.
Some tips for directors
We set out below some practical tips for carrying out your functions as a director:
- Understand the company’s business: Maintain a good knowledge of the company’s activities and financial status.
- Be financially literate: You must be able to read, understand and question the company’s financial statements. Do not be afraid to ask your accountant to explain the material until you are confident that you can fulfil your primary duty of managing and supervising the company’s business.
- Use independent judgment: Apply an independent and inquiring mind to your task. Your duties as a director are owed by you personally, not by the board as a whole. If you have expertise in a specific area, you must not let this create ‘tunnel vision’. Directors are “not relieved of the duty to pay attention to the company’s affairs which might reasonably be expected to attract inquiry, even outside the area of the director’s expertise.1”
- Use of information: Take a diligent and intelligent interest in the information available. If you consider that further information is required in order to make a decision, ask for it.
- Honest mistakes can be made: Directors are only human and can make mistakes. The good news is, so long as you take all reasonable steps to avoid an error, you should avoid breaching your directors’ duties.
Expert and professional advice
When performing your directors’ duties, you may rely on information or advice from company employees, professional advisers, experts and other directors with delegated authority for a particular matter. However, in doing so, you must:
- avoid substituting that advice for your own examination of important matters and the formation of your own opinion. Your duty to fully consider directors’ matters may not be delegated or abdicated;
- be satisfied that the person you are relying on is competent in relation to the subject matter. You must not rely on a person if you know or have reason to believe that such reliance is unwarranted; and
- make proper inquiry where the circumstances indicate further explanation is required.
It is important that you take the time to understand the professional advice and ask questions if you need clarification. Remember also that “the quality of any advice is only as good as the information provided to the professional, on the basis of which he or she is asked to advise” 2. Accordingly, always ensure that information provided to your adviser is accurate and you are clear on the scope of their advice.
Because you could be personally liable for the company’s debts, it is highly advisable to have the company indemnify you or effect insurance for you. However, the company can only cover your potential liability in this way if its constitution permits, therefore, ensuring that your company’s constitution allows for director indemnity and insurance is vital.