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Appointment of directors under Corporation Act, 2001

Discuss about the Duties of directors of a company.

For any company to prosper it is imperative that there should remain at the helm of the affairs of such company a director who is able to manage things efficiently.Like the captain of a ship, the duty of a director is to ensure that the company does its job, but that it does its job well, both economically as well as socially, and to steer the company clear of problems and should the company ever fall into dire straits, help the company recover from such straits as well.

Every aspect of a corporation is somehow controlled by the Corporations Act, 2001 Everything starting from the appointment of directors to the discharge of duties of the directors comes under the purview of the corporations act. Before discussing further about the duties of the directors, it would be prudent if we were to turn our attention to the actual appointment o director under the Corporation Act, 2001.

The definition given in the Corporation Act with regard to directors is broad enough to include within its ambit all officers appointed by a company who perform all, or substantially, the tasks of a managerial nature for the company. From this proposition it is obvious that the directors stand in a fiduciary relationship with the company as a huge amount of trust and confidence is reposed in them and it is mandatory, both legally as well as morally, that they should honor such trust and confidence. Directors again may be subdivided into executive and non-executive. A non-executive director is one who, as the name suggests, has not been appointed in an executive capacity by the organization. Generally such non-executive does not form part of the internal management capacity of a company and instead works in a supervisory capacity from outside the company. They are also termed as ‘independent’ directors. Both such directors have their sets of duties legally specified and mandated for them.

The duties of a director may be basically and broadly divided into the following four heads:

  1. Duty of acting with due care and diligence;
  2. Duty of acting in good faith;
  3. Duty to use the position of director in a proper and valid manner; and
  4. Duty to make proper use of information in the hands of the director.

Now let us consider each such duty in detail.

  1. Duty of acting with due care and diligence: This is an obvious and indispensable part of the directors’ duty. This duty finds reflection in section 180 of the Corporations Act, 2001. A director is expected to act with obvious care and regard to the company’s affairs and also be diligent in his dealings. This point has been subject to much judicial as well as academic scrutiny. One of the first questions that may arise with regard to this point is the yardstick against which the due care and diligence of a director must be measured. To put it more simply, what should the yardstick be? Whether the director should be judged with regard to his own intelligence or with reference to the intelligence of a person of “normal prudence and reason”? 


This question arose in the case of Re City Equitable Fire Insurance Co. Lt. One Bevan holding an influential position in the company created a situation in the company that other directors in the company were made instrumental in his plan. Such was the extent of his plan that it lead to a corporate collapse and other directors were, knowingly or unknowingly, part of his plan. Now the question was whether the other directors had failed in their duty of due care and diligence, because going by the circumstances of the case, one of them being signature of blank cheques by such directors, it may be said to be highly probable that the other directors had in fact failed in such duty.  However court took a holistic view of the case and did not consider a single act of signing blank cheques as evidence of acting without due care and diligence.The Court held that directors had signed in circumstances that did not give rise to any suspicion in the minds of the director, thereby going by such action; the court held that the directors in fact had acted in due care and diligence. However, in the case of Re D'Jan of London Ltd it was held by the court that in case a director simply signs a document without having read the same, that would amount to acting without due care and diligence.

  1. Duty of good faith: This duty is enunciated in section 181 of the Corporations Act, 2001. Here the term good faith implies an honest and bona fide belief. Such belief should be towards the end that whatever the director is doing, he is doing for the benefit of the company and for its ultimate good.

Duties of directors of a company


In the case of Re Smith and Fawcett Ltd the court specifically held that the duty of good faith has been imposed upon the director and thus, ultimately it is the director who must exercise his good faith and not anyone else, not even the courts. Of course, a natural corollary of this duty would be that in case director’s actions lead to an adverse effect on the company’s interests, the directors would have a harder time explaining to the court about the good faith that they employed while taking decision on behalf of the company. In the case of Harlowe’s Nominees Pty Ltd v Woodside (Lake Entrance) Oil Company NL the directors of the company made allotment of share capital to company “B”. Such allotment was done in exercise of discretionary powers of the directors and not through usual process and the ultimate aim of the allotment was to prevent a particular ‘mysterious buyer’ from acquiring further substantial shares in the company. Also company B acted in collaboration with Woodside (Lake Entrance) Oil Company NL in the process of exploration of natural oil and gas. This allotment was challenged by a mystery buyer on the grounds that the allotment did not further the interests of the company and the directors did not act in good faith.  It was held that good faith simply did not imply the bare financial interests of the company. While allowing the shares to have been sold in the market freely would definitely have been more lucrative for the company, the main aim of the allotment was to prevent the mysterious buyer from gaining further substantial shares in the company, therefore effectively allowing the management of the company being transferred to the mysterious buyer. Thus, going by the actions of the directors, it could well be inferred that they did actually act in good faith.

  1. Duty to use the position of director in a proper and valid manner: This duty is found in section 182 of the Corporations Act. The section prohibits a director from using their position in any way that would provide to such director an undue or unwarranted advantage that would otherwise not have come to the direction. Examples of improper use may be said to be influence exercised by directors upon future investment decisions of the company, by virtue of which a director may change his plan accordingly. This section extends not only to the director himself, but also in cases of any undue advantage such director may extend to some other person.

In the case of ASIC v Adler, it was laid down by the Court that the director Adler was in contravention of section 182 because he had mobilized funds to the tune of $ 10 million to be given to PEE by HIHC in the form of a loan. As a result of this transaction, PEE had to suffer losses in its investment because the main aim of such transaction was to jack up the share prices of HIH and thereafter all the shares of HIH held by Adler Corporation were sold and Adler himself was an officer in such corporation. This resulted in PEE facing a huge loss in the market and Adler Corporation gaining an undue profit.

  1. Duty to make proper use of information in the hands of the director: Again the language of this duty might be positive but what this duty essentially implies is that it is incumbent upon the directors not to misuse information that such director may have received simply by virtue of being a director of such company. This duty finds expression in section 183 of the Corporations Act, 2001. The liability is imposed not only on the director but also on any person who receives information for not being a director of any company.

Due care and diligence

An example this section in practice is the case of McNamara v Flavel in which McNamara being the director of a company named Duna World Pty Ltd obtained certain information in such capacity and used that for his own benefit, thereby causing undue loss to his company. Here the court held that the director was acting in obvious breach of his duty. He used such information illegally for his own benefit, but his actions also caused loss to the interests of the company, the facts of the case were very clear and they explicitly pointed that McNamara had acted intentionally and willingly in breach and thus he was held liable.

Conclusion

The four duties discussed above, are in brief, the duties of a director and such duties are non-negotiable. Directors of a company stand in fiduciary relationship with the company and keeping that in mind, directors are supposed to exhibit exceptional and extreme fidelity to a company. It is undeniable that an efficient director can take the company from strength to strength and to help directors achieve such lofty aims, they are given immense powers and discretion. However, as Lord Acton had remarked, “Absolute power corrupts absolutely” so also unbridled power is not given to the directors. In fact the law itself contemplates many checks and balances on the powers of the directors, some of which we discussed here in this article.

Despite that, there have been cases where many directors have in fact contravened the law and have breached their duties, but in such cases the courts have acted promptly and brought the directors to book.

References

Langford, R. (2011). The Duty of Directors to Act Bona Fide in the Interests of the Company: A Positive Fiduciary Duty? Australia and the UK Compared. Journal Of Corporate Law Studies, 11(1), 215-242. https://dx.doi.org/10.5235/147359711795344181

Farrar, J. (2001). Corporate governance in Australia and New Zealand (1st ed.). South Melbourne, Vic.: Oxford University Press.

Yang, T. (Directors' & Controlling Shareholder's Fiduciary Duty and Business Judgment Rule). SSRN Electronic Journal. https://dx.doi.org/10.2139/ssrn.2924306

Fiduciary Duty of Officers and Directors Not to Compete with the Corporation. (1941). Harvard Law Review, 54(7), 1191. https://dx.doi.org/10.2307/1334929

MacDonald, R. The Companies Act 2006 and the Directors' Duty to Disclose. SSRN Electronic Journal. https://dx.doi.org/10.2139/ssrn.1767469

Lee, T. (1987). Limiting Corporate Directors' Liability: Delaware's Section 102(b)(7) and the Erosion of the Directors' Duty of Care. University Of Pennsylvania Law Review, 136(1), 239. https://dx.doi.org/10.2307/3312048

Weiner, W. (1952). Corporations: Officers and Directors: Fiduciary Duty of Officer Purchasing Stock from Shareholder. Michigan Law Review, 51(2), 290. https://dx.doi.org/10.2307/1285722

Bradley, M., & Chen, D. Corporate Governance, Fiduciary Duty of Boards of Directors, and Bondholders’ Wealth. SSRN Electronic Journal. https://dx.doi.org/10.2139/ssrn.1572159

 Better shareholders-better company. (2008) (1st ed.). [Canberra].

George, J. (2004). The duty of care and diligence (1st ed.). Mascot, N.S.W.: Talomin Books.

Redmond, P., & Martin, K. (1997). Judging business judgements (1st ed.). Perth, W.A.: Law Society of Western Australia.

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