Background on directors’ role and their duties
The pivotal issue is to provide Tim advice with regards to the various issues currently being faced by Modern Design Pty Ltd including potential duty breach by directors with reference to both statutory and common law.
It is noteworthy that directors have a key role in the administration and success of the company. Owing to the key role that directors play, there are several duties that are bestowed on them in accordance to both common law and also the statutory law.
The shareholders are the real owners of a company but in order to run the company, directors are appointed. As a result, it is evident that an agency relationship arises whereby the shareholders are the principal while the directors are the agents. On account of the underlying agency relationship, fiduciary duties arise which the directors as agents have to fulfil that are essentially directed towards the principal. The duties arising on account of this relationship are enumerated as follows.
- The directors need to discharge their duties in good faith and must aim to further the shareholders’ interest and thus aim for shareholder wealth maximisation. This arises on account of the underlying agency relationship where the agents need to exercise the authority so as to further the principal’s interest. As a result, directors must act with honesty and should not take actions which are detrimental to company or shareholders (Harvey, 2009).
- The directors need to carry out their designated task with utmost care and due diligence. The implication is that since the directors through their actions or inaction can potentially harm the shareholders by destroying company’s value, hence they must take appropriate care so that their conduct and decision making is not negligent (Gibson and Fraser, 2014).
- The directors also need to stay clear of any situation where conflict of interest is involved since this may prove to be an impediment for the director to safeguard the interest of the company and the shareholders. The directors in such situation can be driven by their own interests that may be supreme to that of company’s and hence such situations need to be avoided (Pathinayake, 2014).
- Also, it is expected that the directors would use their discretion and hence take independent and informed decision in relation to management of the company. Besides, the directors yield a lot of power which is expected to be used for the appropriate power for which it is bestowed. Improper use of power or authority would lead to breach of the common duty of directors towards shareholders and company (Lindgren, 2011).
The appropriate statute related to duties of directors is Corporations Act 2001. The duties of directors that are highlighted are summarised as follows.
- Section 180 – As per s. 180(1), the authority provided to directors by the shareholders should be exhibited with appropriate care and due diligence. The level of care required should be defined as the care that a reasonable person as director would take in the given situation. The violation of s. 180(1) by any director leads to contravention under s.1317E Corporations Act 2001 which leads to civil penalty in the form of fines upto $200,000 as per s. 1317G (Harris, 2014).
The directors in their defence for breach of s. 180(1) can deploy the business judgement rule mentioned as s. 180(2). As per this rule, no liability for the director would arise if the judgement under question had been made with requisite knowledge, good faith and driven by the interest of shareholders (Pathinayake, 2014).
- Section 181 – As per s. 181, the exercise of authority provided to directors should be for the appropriate purpose and in good faith. This duty if breached would lead to civil penalty in line with s.1317E which has been explained above (Cassidy, 2013).
- Section 182 – As per s. 182, the usage of their position must not for gaining material advantages for themselves or their associates. The directors should not assume any judgement which harms the interest of the company. This duty if breached would lead to civil penalty in line with s.1317E which has been explained above (Ciro and Symes, 2014).
- Section 183 – As per s. 183, the usage of privileged information that directors gain access to owing to their position must not be deployed for gaining material advantage for ownself or associates. The directors should not use this privileged private information for harming the interest of the company. This duty if breached would lead to civil penalty in line with s.1317E which has been explained above (Harris, 2013).
- Section 184 – As per s. 184, the directors while making judgement need to do so in good faith and hence must not behave in an dishonest manner. This is because this kind of behaviour may adversely impact the shareholders interest and therefore not acceptable. Unlike breach of other duties, this is primarily intentional in nature and hence the criminal liabilities are imposed for the breach of this section which would include capital punishment along with fines (Harris, 2014).
- Section 190 – As per s. 190(1), in event of delegation of authority to any delegate by the director, he/she would be held responsible for the actions of the delegate. However, exemption to the above would be provided as per s. 190(2), if the delegate has the requisite competence and there are reasonable grounds to believe that the delegate would faithfully discharge the duties of directors (Ciro and Symes, 2014).
- Section 191 – As per s. 191, it is imperative that any material personal interest of the director must be disclosed as it leads to conflict of interest situation. In such a situation, the other directors can take decision with regards to certain decisions where the director may not be involved owing to conflict of interest. This is aimed at ensuring that the interest of the shareholders is safeguarded. The breach of this section results in strict liability as outlined in the Criminal Code s. 6-1 (Cassidy, 2013).
- Section 286 – As per s. 286, the directors are required to undertake all necessary measures for ensuring that the financial transactions of the company are captured in the form of proper books of accounts. The breach of this section results in strict liability as outlined in the Criminal Code s. 6-1 (Pathinayake, 2014).
- Section 588G – As per s. 588G, all requisite measures must be undertaken by the directors so as to maintain solvency. Further, while assuming debt or any liability, the directors should consider the repaying capacity of the company and must refrain from assumption of debt which can lead to company becoming insolvent. Any breach in this regards leads to both strict and absolute liability for the underlying director (Harris, 2013).
A relevant case is Gillfillan & Ors v ASIC [2012] NSWCA 370 at 15. This case highlights that participation of the directors in the board meeting and informed voting is part of s. 180(1). In order to facilitate the same, appropriate technological aids may also be deployed. However, failure on the part of the directors to engage in informed voting, non-attendance of board meetings and non-participation in board discussions leads to breach of s. 180(1).
The most famous case in recent history pertaining to breach of duties of directors is ASIC v Adler and 4 Ors [2002] NSWSC 171 which pertains to the HIH Insurance failure. In this case, the directors were found to have breached a host of the statutory and common law duties levied on them. This led to both civil and criminal penalties for the defaulting directors.
Also, in Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023, it was highlighted that actual breach of s. 180(1) is not necessary and conduct of the director which can potentially harm the company and threaten its existence amounts to breach of duty to care towards the shareholders and hence is to be treated as an actual breach.
Relevant statute and duties of directors under it
For Model Design Pty Ltd, there are three directors namely Alana, Ursula and Tim and the conduct of all these directors needs to be analysed in the light of common and statutory law duties imposed on the directors.
Alana is retired accountant but has not kept her updates with the developments and legislation is her field. She does not have any relevant expertise or experience of the design industry. Her representation on the board is only on account of “financial knowledge “ attributed to her background. However, despite her presence, it is known that the company is facing liquidity issues owing to neither of the directors understanding the interaction between cash flows and profits. The breach of duty for Alana is discussed below.
- There is a breach of common duty to care since Alana despite her background does not have requisite knowledge to take appropriate decisions for the company. Also, s. 180(1) is breached since any reasonable person in her position and background would have the knowledge about cash flow and profit interlinkage. Further, it is noteworthy that owing to her insufficient knowledge, the existence of the company is threatened as the creditors are demanding cash on delivery of supplies and additional capital is required to be infused. This is because the other directors lack financial knowledge and thereby rely on Alana to provide guidance in financial decision making.
- Besides, there could be potential breach of s. 191 by Alana is she has plans to start her own business with or without Ursula. Considering that Ursula is keen to start her own business but lacks financial knowledge, the possibility of Ursula and Alana tying up seems quite reasonable.
Based on the given facts, it is apparent that Ursula is primarily concerned with running the operations of the business owing to her rich client network and superior experience related to the design industry. Since she does not consider herself to be good in management decisions, hence she does not attend the board meetings and instead leaves the strategic decisions to the other directors. Also, it is known that she wants to start her own business in the same field as company. Besides, she also siphons off company’s inventory with the assistances from Bob (warehouse manager). The breach of duty for Ursula is discussed below.
- There is a breach of s. 180(1) along with the common duty to act with care and due diligence. This is because Ursula does not attend the board meeting citing that she is busy but infact she is not interested and wants to restrict to operational aspects only. With the industry expertise that she has, any reasonable person in her position would assume that her expertise would be quite useful to the board for making key strategic decisions. Also, as a director, she owes duty to care towards the shareholders but her absence from board meetings is negligent.
- Her conduct also violates s. 182 and s. 184 Corporations Act. Besides, the common duty of using the authority for proper purpose in good faith is also breached. This is because, she is siphoning off high value inventory which is causing loss to the company and also the shareholders. Ursula being the head of operations is abusing her position as a director for obtaining financial advantage with her dishonest conduct.
- Her conduct is in breach of s. 191 also since there is material conflict of interest considering that she intends to start the same business as the company on her own. She has failed to disclose the same to the board officially. Further, to discharge the common duty, it would be expected that she should avoid such conflict of interest and hence potentially should resign from position of director but she continues to be the director.
Tim has the responsibility to deal with advertisement and marketing. He lacks financial knowledge about business for which he relies on Alana. The business has faced cash crunch in the past and he has played an active part in sorting out these issues. Also, he is considering raising incremental capital for the business. The breach of duty for Tim is discussed below.
- His conduct violates s.180 as the company is facing cash crunch and potential liquidation in future owing to inability of the board to exhibit prudent cash management. The creditors have also made it clear that they would deliver only on cash. This is adversely impacting the company but still Tim intends to stick with Alana despite her failure in this regards. Also, no consultant or accountant seems to have been appointed for rectifying this issue. Besides, Tim has not made any attempts to force Ursula to attend the board meetings and to clarify potential conflict of interest.
The discussion in the previous section clearly highlights that the conduct of the directors has been faulty as there has been a breach of duties of directors under statutory and common law. The respective liabilities that could result for the directors are discussed below.
Alana – Currently, there has been a violation of s. 180(1) only whose contravention leads to civil penalty as outlined in s.1317G whereby a maximum fine of $ 200,000 can be levied on her which would be payable to the Commonwealth. Besides, in case of any future liquidation of the company and resultant losses, then Alana could have personal liability with regards to the losses and thus pay damages.
Ursula – There has been violation of various provisions related to s. 180, s. 182 which would result in civil penalty leading to fines and potential disqualification from being director. Also, there has been intention wrongdoing on part of Ursula which could also result in criminal charges especially on account of siphoning off of the inventory. She would also be liable to pay the company for the inventory that has been siphoned off by her.
Tim – There has been violation of s. 180(1) which would attract civil penalty in terms of fine under s.1317E. Further, for the losses suffered by the company owing to misconduct of the directors, the shareholders could file lawsuit for damages where the directors could be personally held liable.
Recommendations & Conclusions
The discussion carried out above is indicative of the improper conduct by the directors of the company owing to which there has been violation of both common and statutory duties related to directors. Additionally, in wake of the given scenario, the recommendations are as follows.
- Alana should be removed from the position of director owing to her lack of any meaningful value addition and non-possession of requisite knowledge. In place of her, Larry ought to appointed in the position of director considering that he has requisite financial expertise and has been actively involved with Tim in resolving credit related issues faced by company.
- Ursula should also be removed from the position of director since there is a potential conflict of interest, dishonest conduct and also because she does not want any involvement in the managerial decision making. She wants to be limited only to operations and hence should be restricted as head of operations. Also, the other directors ought to be engaged in the relationship building with client so that the company can manage business even after her departure.
- A suitable substitute of Bob needs to be found considering the integrity issues he had and also he must not be promoted to the position of director.
- Tim also needs to appoint a consultant or accountant for cash management of the business as this could potentially lead to bankruptcy and violation of duty under s. 588G.
References
Cassidy, J. (2013) Corporations Law Text and Essential Cases 4th ed. Sydney: Federation Press.
Ciro, T. and Symes, C. (2014) Corporations Law in Principle 9th ed. Sydney: LBC Thomson Reuters
Gibson, A. and Fraser, D. (2014) Business Law 8th ed. Sydney: Pearson Publications.
Harris, J. (2013) Butterworths Questions and Answers Corporations Law 4th ed. Sydney: LexisNexis Australia.
Harris, J. (2014) Corporations Law. 2nd ed. Sydney: LexisNexis Study Guide.
Harvey, C. (2009) Foundations of Australian law 3rd ed. Victoria: Tilde University Press.
Lindgren, K.E. (2011) Vermeesch and Lindgren’s Business Law of Australia 12th ed. Sydney: LexisNexis Publications
Pathinayake, A. (2014) Commercial and Corporations Law 2nd ed. Sydney: Thomson-Reuters.
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