Duties of Company Directors - Case Study Example

TABLE OF CONTENTS Duties of Company Directors 2 Issue 2 Rule of Law 2 Application 3 Whether Popper is liable for a breach of duty of care. 3 Whether Jones is liable for any breach of duties of care and skill. 6 Whether Brown is liable for any breach of duty for failing to take an active part in the negotiations of the company. 9 Conclusion 11 Duties of Company Directors Issue The issues to be addressed are; whether Popper is liable for breach of duty of disclosure, under section 191 of the Corporations Act 2001, in respect of the land purchased by the company from his daughter. In addition, it is to be ascertained whether Brown had breached any fiduciary duty under the Corporations Act 2001. It is to be ascertained whether Brown is liable for having neglected his duties of care and diligence, as he had merely relied on the statements of the other directors, without scrutinising them for their accuracy. Finally, the liability of the directors is to be ascertained, regarding their duty to abstain from trading, when the company is insolvent or on the verge of becoming insolvent. As such, it is to be determined, whether Jones and Brown are liable for breach of any fiduciary duties, Vis – a – Vis the Electrics Ltd. Rule of Law Section 191 of the Corporations Act 2001, relates to the duty of disclosure of conflicting interests, in respect of a company’s director. Sections 180 to 184 of the Corporations Act 2001, deal with the duties of directors. The directors of a company are required to act with good faith and in the best interests of the company. They should ensure, at all times that there is no conflict of interests or bias in the actions performed by them on behalf of the company. The ratification of the shareholders’ is essential for any contract, if the party to the contract is a director of the company1. Section 180(2) of the Corporation Act deals with the statutory business judgement rule. This rule applies to breaches of the statutory duty of care, which is specified in section 180(1) of the Corporations Act 2001. The business judgment rule provides protection to directors, when they take a judgment in good faith for a proper purpose. It is also applicable, when the director does not have a material personal interest in the subject matter of the judgment and reasonable believes that the judgment is in the best interests of the company2. Section 588G of the Corporation Act 2001, imposes a duty on the directors, whereby they should not trade, while the company is liable to become insolvent. Application Whether Popper is liable for a breach of duty of care. A public company, namely, the Electrics Ltd, is represented by its managing director, Popper and Jones and Brown as the remaining directors. Popper proposed the purchase of a tract of land, owned by his daughter, by Electrics Ltd. Popper gained control of 51% of this company’s shares, by his stratagem of holding of proxies for a number of institutions. The proposal for purchase was supported by the company’s property portfolio manager, who was a henchman of Popper. This served to mislead Jones; moreover, Brown, who was too old to participate actively in the affairs of the company, left the matter to the discretion of Popper and Jones. The directors of a company should act in the best interests of the company. They are under a fiduciary duty towards the company, to act in this manner. The directors of a company should exercise their powers as directors, only for legitimate purposes. Their actions should be appropriate, in good faith and aimed at furthering the interests of the company. As such, the directors of a company should exercise due care and diligence, while discharging their duties. Moreover, they are expected to discharge their duties as reasonable persons3. A director would be held liable if he breached his duty, in the following instances. First, the omission of information while preparing financial reports pertaining to the company; second, the wilful preparation of misleading financial reports; third, failure to disclose the doubtful debts of the company; fourth, exaggerates the profits made by the company; and fifth, wilful inflation of the value of assets of the company. All these activities render the director liable for legal action on charges of violation of statutory duties4. In Aberdeen Ry v Blaikie Bros, it was held that the company could recover from the profits made by a director, on the basis of his status in the company. A director of a company has to disclose his interests in any transaction entered into by the company, to the board of directors. As such, the directors have to disclose their interests in the contracts with the company5. In Thorby v Goldberg, the court held that the directors could negotiate a contract on behalf of the company. While doing so, they had to confirm that the contract was in the best interests of the company6. The Howard Smith Ltd v Ampol Ltd case had emerged as a leading case that dealt with the duties of the directors of a company. In this case, it was held that the directors should act only for the bona fide purposes of the company. The directors of a company were precluded from abusing their position, in the company, to improve their individual financial status. In this case, the shares were issued with the intention of diluting the decision-making power of the shareholders and to alter the majority control. Under such circumstances, the courts declare the purpose behind the issue of such shares to be improper7. In Aberdeen Railway v Blaikie Bros, the court had to decide whether the director of a company was precluded from entering into a contract on behalf of that company with himself or a partnership firm, in which he was a partner. The court ruled that the director could form such contracts, only if he disclosed his personal interest8. Whether Jones is liable for any breach of duties of care and skill. Through a number of decisions, the courts have firmly established that directors play a crucial role in the management of the company. The courts have categorically declared the importance and absolute nature of the duties of a director. The latter are expected to participate, actively in the undertakings of the company. Two important cases in this area are ASIC v Plymin9 and DCT v Clark10, which further reinforced the duties of directors11. These cases, considered the issue of whether directors could plead ignorance of the company’s affairs, in order to circumvent liability. It was held that the directors of a company had to participate in the management of the company, and that they would be rendered automatically liable for the affairs of the company. Thus, the directors of a company will be punished for inactivity on their part that leads to the mismanagement of the company. This ruling promotes accountability in directors and makes them responsible for the acts they perform in such capacity12. In Daniels v Anderson the court ruled that the director of a company was deemed to be liable. This director had relied on the reports provided by some of the other directors, and as a consequence, he had failed to discern that the affairs of the company were not being managed properly. The court went on to declare that the director of a company was required to adopt preventive measures of a reasonable nature, in order to prevent investments in highly risky ventures13. In Deputy Commissioner of Taxation v Clark, an attempt was endeavoured by one of the directors of the company to evade liability. Specifically, this director declared that she had been nominated a director, at the behest of her husband, who was also a director of the company.14 The appellate court of New South Wales, scrutinised the status of the so called sleeping director, and concluded that certain duties and responsibilities were mandatory for any director, in respect of that director’s participation in the management of the company. The court opined that the total failure of the defendant to participate did not constitute a valid reason for being accorded protection under section 588FGB of the Corporations Act 2001. As a result, this sleeping or inactive director was deemed to be liable for the several infringements of the Corporations Act 2001 that had transpired in the company15. The decision of the NSW Supreme Court In the case of Australian Securities and Investments Commission v Macdonald proved to be a monumental decision in the history of Australian corporate governance. It raised various questions regarding the duty of care to be performed by the directors of a company. It also described the extent to which they could depend upon the information procured from other sources16. The directors of a company are empowered to delegate their powers and duties to suitable third parties. Under such circumstances, they should provide adequate information with regard to the company’s financial and other relevant matters to the delegated persons. The directors have to verify the documents and accounts of the company, prepared by the persons to whom they had delegated power, with regard to financial issues. It is essential for the directors to ensure that the financial statements prepared by persons to whom they had delegated power, are not misleading. If a director is found to have failed to adhere to these duties, then he will be deemed to have breached his statutory duties17. The law provides certain protections to the directors of a company, from an alleged breach of duty. Such protection is available, if the director can establish that he had acted in good faith and for some appropriate purpose. They must prove that they had done their best to ensure that the financial statements provided were true and fair. Moreover, they must prove that they had reasonably believed that the statements were correct and that their assessment was in the best interests of the company18. In our problem, Jones did not display good faith, as he had relied upon Poppers evaluation of the proposed land. He should have verified the facts from other reliable sources. Whether Brown is liable for any breach of duty for failing to take an active part in the negotiations of the company. In Re County Palliative Loan & Discount Co, the court held that the board of directors could not delegate its power of discretion to others, until and unless there was an express authority to do so19. The delegation of duty to a third person to prepare the accounts does not automatically relieve the director from responsibility. Consequently, the director of a company is responsible for the preparation of financial statements of the company. Thus, a number of duties have been specified, which the directors must discharge, regarding the financial accounts of the company20. Under the provisions of section 198D of the Corporation Act 2001, directors of a company may delegate their powers to a committee of directors, another director, and an employee of the company or any other person21. The directors can delegate it to a number of companies if they find such a course of action to be necessary and appropriate. The committee can exercise the powers it receives through the delegation. The exercise of this power by such committees is deemed to have been exercised by the directors of the company. In our problem there is no reason for Brown to accept the decision of others, without personal assessment. His absence cannot relieve him from his fiduciary duties towards the company. In Wilkinson v Dodd, it was held that the directors of a company were under a continuing obligation to keep themselves informed about the activities of the company. Directors should be vigilant, and they should not permit corporate misconduct. Under this duty, they cannot claim that they had failed to notice the misconduct, because they are paid to protect the company from misconduct or wrongdoing22. In Williams v McKay, it was held that the directors were not required to monitor the day to day activities of the company. However, they were required to undertake a general monitoring of the company’s corporate affairs and policies23. Conclusion In this problem Popper, as the managing Director of the company, proposed to purchase land on behalf of the company from his daughter. This purchase was to be at a price that was substantially higher that it’s true value. He had disclosed his personal interest in the transaction to the other directors of the company. However, such mere disclosure does not relieve him from his fiduciary duties towards the company. The common law reposes a duty of trust and good faith on the directors of a company, and requires them to act as reasonable individuals, while taking decisions on behalf of and in the best interests of the company. Popper was well aware of the fact that the value of the property would decrease, due to zoning events. He colluded with the company’s property manager and obtained a financial report from the latter. This report stated an inflated price of the land. In addition, Popper deliberately concealed the fact that the value of that piece of land would reduce in the future, from the other directors of the company. Thus, Popper had breached the duty to act honestly in the best interests of the company, under the Provisions of the Corporations Act 2001. Popper had failed to comply with the duties of a director, as specified in the Corporations Act 2001. The defence of the business judgement rule will not be applicable to him; since, his judgement regarding the purchase of the land is not in the best interests of the company. He is liable under the provisions of the Corporations Act 2001. Jones, realised that the value of the proposed property, declared by Popper was false and that this falsehood was being perpetrated with the active connivance of the company’s proposal manager, who was a close friend of Popper. Initially, Jones was suspicious regarding the valuation of the property. Nevertheless, he did not obtain a correct valuation through other reliable sources. This indicates that Jones did not act in the best interests of the company. Consequently, he had breached statutory and common law duties, in respect of a director’s duties. Hence, he is liable under the provisions of the Corporations Act 2001. The directors Popper, Brown and Jones indulged in highly speculative activity, when the markets were suffering from the impact of a recession. Directors have to ensure the best interests of the company at all times, especially during recession. Activities that are detrimental to the interests of the company render the agreement void or voidable. Directors are liable for breach of duty of care under the Corporations Act 2001. Brown was another director in the company. However, he never pursued the matters of the company, in an individual manner, due to old age. As per the case law discussed, an inactive director cannot escape liability for breach of duties. He had relied on the decision of other members, without monitoring the affairs of the company, independently. Brown is liable for breach of duties of trust and fidelity under the provisions of the Corporations Act 2001. BIBLIOGRAPHY 1. Case Law Aberdeen Railway Co v Blaikie Brothers (1854) 1 Macq 461 Aberdeen Railway v Blaikie Bros (1843-60) All ER 250 Australian Securities and Investments Commission v Macdonald (No11) [2009] NSWSC 287 Australian Securities and Investments Commission v Plymin (No 1) (2003) 46 ACSR 126 Daniels v Anderson (1995) 16 ACSR 607 Deputy Commissioner of Taxation v Clark [2003] NAWCA 91 Deputy Commissioner of Taxation v Clark (2003) 57 NSWLR 113 Howard Smith Ltd v Ampol Petroleum Ltd (1974) AC 821 Re County Pallative Loan & Discount Co; Cartmell’s Case (1874) Thorby v Goldberg (1964) HCA 41 Wilkinson v. Dodd (1885) 40 NJEq 123 Williams v. McKay (I885) 40 NJEq I89 2. Legislation Corporations Act 2001 (Cth) 3. Other Sources Christopher Bevan, Director’s Duties < http://www.findlaw.com.au/articles/32/directors-duties.aspx> at 26 September 2010 Demetra Arsalidou, To be Active or Inactive: Is this a ‘New’ Question for Company Directors? (2003) Deakin Law Review < http://www.austlii.edu.au/au/journals/DeakinLRev/2003/17.html> at 26 September 2010 John Tesarsch and Jane Tiller, Australia: Corporate Regulator Fails Against One mondaq Corporate/Company Law at 26 September 2010 Michele Muscillo and Sharon Robson, Australia: Directors’ Duties and Financial Reporting (2009) < http://www.mondaq.com/australia/article.asp?articleid=85500&login=true > at 26 September 2010 Read More