DEF Ltd was incorporated on January 2011 and was floated on the ASX in March 2011, having raised $20 million from investors. The company is primarily involved in mining and exploration activities in the Pilbara region of Western Australia. DEF Ltd have four directors: Apollo, Rocky, Drago and Clubber. Both Apollo and Rocky are executive directors. Rocky is the company's chief executive officer. Clubber is the company's chair. Drago is the company's chief financial officer. The company began exploration activities in July 2011. After drilling a number of sites, a geological survey was commissioned and the results from the mine wells were tested. The results from the survey reveal that the mining site has low levels of gold deposits and is considered to be uncommercial. The company has already spent $5 million. At a recent meeting, the board considers whether to abandon its mining activities and return the company's remaining capital back to its shareholders. Both Apollo and Rocky are eternal optimists and never know when to quit. They both argue that the company is on the verge of a major discovery and should continue with its exploration activities. Clubber and Drago are less optimistic and suggest that the company's remaining capital should be returned back to investors. To avoid another heated confrontation, they agree with Rocky and Apollo that the company should continue with its drilling program. At the completion of the drilling activities in 2012, all of the company's capital has been exhausted and there have been no major discoveries.
The directors of corporations owe a number of duties towards the companies controlled by them. In this regard, there is a significant duty of the directors which requires them to exercise due care and diligence while discharging their duties. This duty of the directors of corporations has been prescribed by the general law and also by the Corporations Act in section 180. This duty requires that the directors should not being negligent while performing their duties. As a result of this duty, it is important that reasonable care is taken by the directors while performing their duties for the corporation. The cause of action in this case is similar to that under the normal negligence provided by the tort law and it also follows similar rules like there should be a breach of duty, damages should be established, causation and remoteness etc.. In this regard, the required standard of care has to be evaluated by:
The care that can be expected from another person under similar circumstances ( Re Brazilian Rubber Plantations (1911).
What can be reasonably expected from each director of the company, keeping in mind the knowledge and experience of such director and not by considering but would be considered as reasonable by the court.
The answer to the question if reasonable care and diligence has been exercised by a director can only be given by maintaining a balance between the foreseeable risks of harm as compared to the potential benefits that can reasonably be expected to be derived by the company from such conduct (ASIC v Doyle (2001).
In this regard it also needs to be noted that the executive directors can also be held to a higher standard of care in accordance with their contract of employment. Generally there is a covenant present in the service contracts of executive directors according to which, the director is required to meet the performance standards that are comparable to professional managers. At the same time if such a provision is not expressly present in the contract, it can be considered as an implied term of the contract according to which the director of the company has to perform his or her duties with same care and diligence, if not skill, that is exercised by the professional managers (Lister v Romford Ice and Cold Storage Co Ltd, 1957).
Apart from the general law, the duty of care imposed on the directors of companies has also been provided by statute. In this way, the general law duty of care is supplemented by the duty of care and diligence that has been provided by the Corporations Act in Section 180. According to this provision, a director or other officer of the company is required to use the same level of care and diligence that would have been used by any other reasonable person if such person is the director or officer of the company under similar circumstances and occupied the same office and had similar responsibilities. An important thing that needs to be noted in this regard is that in such a case, a proof of loss is not required. Therefore only the failure on the part of the director to use the standard of care is enough. On the other hand, in case of the duty of care provided by general law, a proof of loss is recorded. However, at the same time, the standard of care that has to be used in case of the statutory duty of care is not higher as compared to the similar duty provided by the general law (ASIC v Adler). In this way, a civil penalty provision has been provided by section 180 and in case of the contravention of this provision by the director of officer of the company, a penalty and compensation may be attracted apart from other statutory remedies and the remedies provided by general law and also the obligations that may arise under the contract of employment. At the same time, in 2000, the criminal sanctions have been removed on the ground that the concept of negligence is not consistent with dishonesty due to the reason that negligence suggests that there is an active awareness of the wrongdoing instead of the failure to use the required care and diligence.
At the same time, the statute also provides certain differences to the directors. Therefore, defenses available to the directors in case of the breach of duty of care include the business judgment rule, the delegation defense and the reliance defense. According to reference provided by the business judgment rule, a director can be protected in case it was legitimately believed by the director and in good faith that a right decision is being made by them. In this way, this rule shows the reluctance of the court to interfere with the genuine business decisions made by the directors. The reason is that it is not for the courts to decide if the business decisions that have been made by the directors or officers of the company were correct or not as the judges are not the experts in business. In this regard, it needs to be noted that the protection provided by the business judgment rule is available against the statutory duty of care and also the duty provided under the general law. The business judgment rule has been mentioned in s180(2) of the Corporations Act.
(a) In the present case, it can be said that the duty of care and diligence has been breached by Apollo and Rocky as the directors of DEF Ltd. when they failed to consider the results of the survey that the mining site was un-commercial I decided to continue with the mining activities.
(b) The only difference that is available to Rocky and Apollo in this case can be the defense provided by s180(2) which states the business judgment rule according to which, the court does not question a decision that has been made by the directors in good faith, without any personal interest and under the impression that such a decision is in the interests of the company.
(c) As the chairperson of DEF Ltd. it was the duty of Clubber to stop the company from continuing with the mining operations when it has been clearly stated by the geological survey that the mining at that site is un-commercial. However, instead of returning the remaining capital to the investors, Clubber allowed the company to continue with its operations only in order to avoid a heated confrontation with other directors of the company although he was not optimistic regarding the results of such operations.
(d) As the chief financial officer of DEF Ltd, it was also the duty of Drago to prevent the company from continuing with the mining operations at that particular site after the geological survey has reported that it was not commercially viable. As a result, Drago has also breached his general law duty of care and diligence as well as the statutory duty provided by the Corporations Act.
According to the corporations law in Australia, a power has been granted to the directors to use defensive measures however these powers are subject to the statutory duties of the directors and also the general law duties which include the duty of care and diligence, avoiding conflicts of interest and also the need to act bona fide and in the best interests of the company as a whole. In case of a takeover scenario, the duty that is most relevant is the duty of the directors to act bona fide, in the best interests of the company and as a result, the city has received significant attention by the courts. In this regard, a test has been developed by the courts in order to decide if the directors have complied with the relevant duty and this test is known as the proper purpose test. This test provides that the directors have to use their powers for a proper purpose only.
Defensive measures may be taken by the directors of the company in order to resist the takeover efforts of other companies. Therefore measures like the strategic issue of shares to rent the parties or introducing amendments in the article of the Association of the company and other use or the abuse of the powers of the directors can be in accordance with the requirements of the law from the directors of companies as its fiduciary agents if such powers have been used by the directors bona fide and also for the benefit of the Corporation. While the defensive measures due to which higher prices may be derived from the bidders are considered as advantageous for the members of the company. On the other hand, the defensive measures in case of which the management of the company is involved in efforts to defeat the bid of other parties "at all costs" for the measures that have been taken by the directors without reasonable investigation and good faith or the measures that can be simply said to be unreasonable may result in a real loss to the members of the company and such measures may also be rejected by the law.
In such a case, it is important to consider the motive behind the action of the directors and not the result of such action taken by the directors. Therefore if the directors have acted in such a way due to which a financial loss has been caused to the shareholders of the company, the directors may still be protected if and they have acted on their judgment considering it to be advantageous for the shareholders of the company.
In order to decide in order to decide if the probable passivity of the directors have been breached in a particular case, the court is required to evaluate the purpose of the power in question and at the same time, it is also required to decide if the power has been used by the directors otherwise than for a proper purpose or for the purpose for which such power has been provided to the directors. For the purpose of deciding this question, intention, motive and the purpose of several individuals need to be decided, which can be a complex task. In this regard, test has been provided by Dixon J in Mills v Mills according to which if the substantial purpose can be considered as the proper purpose, the directors' action can also be considered as valid.
In the present case, a hostile takeover bid has been made by Anglo Brit for Citrus Ltd. But in order to defeat the takeover bid of Anglo Brit, the directors of Citrus come out with a plan. According to this plan, the company is going to provide a loan of $20 million to one of its directors Mr. Lang. The purpose of this loan is to purchase shares in Citrus Ltd so that the price of the shares of the company may increase. If this happens, Anglo Brit will have to increase its offer to the shareholders of Citrus Ltd if the company wants to be successful in its takeover bid. In such a case, it needs to be seen if the action of the directors of Citrus Ltd can be said to be for a proper purpose and at the same time, it is also required that such an action should not result in any loss to the shareholders of Citrus Ltd. If this is not the case, then it cannot be said that the directors of Citrus Ltd. have breached their duty to act in good faith and also in the best interests of the Corporation as well as the duty of the directors to act for a proper purpose. On the other hand, if the loan given to Mr. Lang cannot be said to be given for a proper purpose and also it has resulted in the breach of the duty of the directors to act in good faith, it can be said that the directors of Citrus Ltd. were in the breach of their duties. However in the present case, the action of the directors of Citrus Ltd. has not resulted in any loss to the shareholders of Citrus Ltd. and at the same time, the act of giving loan to Mr. Lang was done by them in good faith, it can be said that they have not breached their duties.
At the same time, the election cannot be taken by Anglo Brit Ltd. regarding the conduct and the tactics adopted by the directors of Citrus Ltd. because the directors have acted in good faith and also in the best interests of Citrus Ltd.
Y.F. Danziger, 'Directors and Takeovers' (2) (1984) 5 Co. L. 217
ASIC v Adler  NSWSC 171
ASIC v Doyle  WASC 187
Lister v Romford Ice and Cold Storage Co Ltd  AC 555
Mills v Mills (1938) 60 CLR 150
re Brazilian Rubber Plantations and Estates Ltd (1911) 1 Ch 425.