Duties and Responsibilities of Directors and Officers PROFESSOR BOB BAXT 18TH EDITION

Transcription

1 Duties and Responsibilities of Directors and Officers PROFESSOR BOB BAXT 18TH EDITION A U S T R A L I A N I N S T I T U T E O F C O M P A N Y D I R E C T O R S

2 AICD EDUCATION DIRECTOR DUTIES & RESPONSIBILITIES - UPDATE A Good Night s Sleep Something Worth Having The Director Duties & Responsibilities - Update half-day program provides concise and essential information. It outlines recent and forthcoming changes within the legal and regulatory environment, and how they affect you and your company. For program dates or more information, call the AICD on or visit

3 Duties and Responsibilities of Directors and Officers 18th edition August 2005 Professor Robert Baxt

4 Disclaimer Australian Institute of Company Directors (AICD) has published this work to assist directors. This material should not be relied upon as a substitute for legal or for other professional advice. No reader should act, or fail to act, on the basis of any of this material as it is for general information only, and so professional advisers should be consulted about any matter contained herein. AICD, its officers, the author, and editor, disclaim all and any liability for any action taken or not taken because of relying on information provided in this work. The copyright of this material is vested in AICD and in the author. No part of this material can be reproduced or transmitted in any form, or by any means electronic or mechanical, including photocopying, recording or by any information storage and retrieval systems without the written permission of AICD and the author. The information contained in this work was correct at the time of printing. Published in August 2005 by: The Australian Institute of Company Directors Level 2, National Australia Bank House 255 George Street Sydney NSW 2000 Phone: Fax: First edition published in June 1982 Professor R Baxt and Australian Institute of Company Directors Printed by Southwood Press Pty Ltd National Library of Australia Cataloguing in Publication Data Baxt, R. (Robert), 1938 Duties and Responsibilities of Company Directors and Officers 18th edition Bibliography ISSN ISBN X 1. Directors of corporations legal status, laws, etc. Australia. I. Australian Institute of Company Directors. II. Title

5 Contents Preface Key terms ix x 1 Introduction 1 2 The company and its components 7 1 The structure of a company 7 (i) Public or private company 7 (ii) Limited or guarantee company 8 2 Parts of a company 8 (i) Number of shareholders 8 (ii) Number of directors 9 3 The company as a separate entity or person 9 4 The Salomon case 11 5 Limited liability and when it does not apply 12 6 Definition of director 14 (i) De facto directors 14 (ii) Shadow directors 17 (iii) Nominee directors 19 (iv) Alternate directors 19 (v) Who may be a director? 23 7 Officers 24 8 Disqualification of directors 26 9 Some interesting cases on disqualification of directors and the discretion of the court The rights of company directors Resignation by directors 36 3 The duties of directors a broad overview 39 1 Introduction 39 2 To whom is the director s duty owed? 39 3 The primary duty of directors is to the company, that is to the shareholders/members now and future 40 4 Duties to creditors 42 5 The group of companies 45 6 Do nominee directors owe duties to their nominators? 46 7 Duties to individual shareholders 51 iii

6 iv Duties and Responsibilities of Directors and Officers 8 Do directors owe a duty to employees? 52 9 Do directors owe a duty to society? Concluding remarks 54 4 Duties to act honestly and to avoid conflicts of interest 57 1 The duty to act in good faith and in the best interests of the company (the former duty to act honestly) 57 2 Can directors be liable for fraud, as well as a breach of their duty to act in good faith? 62 3 Duty to avoid a conflict of duty and interest 64 4 Statutory duty not to misuse the position of director section Duty not to make improper use of information (s. 183 of the Act) 73 6 Duty not to abuse a corporate opportunity 75 7 Penalties 78 8 Double jeopardy 78 9 Can shareholders forgive breaches of duty? Conclusion 80 5 Duty to act with care and diligence 81 1 Introduction 81 2 The common law background 82 3 The Adler litigation and section 180 of the Act 84 4 Responsibilities of specific types of directors chairmen, executive and non-executive directors 87 (i) General comments 87 (ii) The AWA case at first instance 88 (iii) Post AWA cases 90 (iv) The AWA case on appeal 92 (v) Some recent comments on the role of specific types of directors 97 (a) The chairman 97 (b) The chief executive officer 98 (c) Other directors 99 5 Duty of care in conflict situations The statutory business judgment rule Other statutory amendments to clarify the position of directors 106 iv

7 Contents v 6 Day-to-day duties Reliance on other directors Duties in relation to accounts Other danger areas 119 (i) Misleading statements 119 (ii) Continuous disclosure and the new infringement notice regime 119 (iii) Duties to avoid fraud and other wrongs Insolvent trading Introduction Basic duty to avoid insolvent trading section 588G Defences to insolvent trading 125 (i) General comments 125 (ii) The Elliott case 126 (iii) Delegation of duty and insolvent trading 129 (iv) Other cases on s. 588H defences Shadow directors and insolvent trading Who may sue for the company s debts in an insolvent trading scenario? Groups of companies and insolvent trading Insurance and forgiveness Introduction Insurance and indemnity The court s ability to forgive directors of breaches of the Act 140 (i) Overview 140 (ii) The rationale for sections 1318 and 1317S 141 (iii) The decision in Edwards (the James Hardie Research Fund case) Forgiveness by shareholders/the company 143 (i) General overview 143 (ii) Directors forgiving their own misdeeds 145 (iii) No forgiveness if fraud is present Remedies for shareholders general law and statutory Overview The statutory derivative action Some examples of the new provision in operation 153 v

8 vi Duties and Responsibilities of Directors and Officers 4 Other statutory remedies The oppression remedy: s (i) Overview 155 (ii) Some earlier examples 157 (iii) Can a minority shareholder be held to oppress a majority shareholder? 159 (iv) More examples Section 1324 injunctions Section Section 247A: the right to inspect books Various actions by ASIC on behalf of shareholders Section 50 of ASIC Act Division of power between shareholders and directors Traps for the unwary director Pre-registration contracts Companies financing share transactions illegally Liability of directors for debts incurred where the company is acting as a trustee Liabilities of directors for payment of unlawful dividends Personal liability under other acts Liability as an accessory: s. 79 of the Act Insider trading: s. 1043A Strict liability of directors Continuous disclosure/prospectuses Infringement notice regime Takeovers Related party transactions The liability of a company for the acts of its agents Criminal liability of directors in actions involving their own companies The doctrine of ultra vires and the powers of directors Directors and superannuation funds The operation of s. 52 of the Trade Practices Act, s. 995 of the Act and specific provisions of the ASIC Act 184 Appendix Angas Law Services Pty Ltd (In Liquidation) v. Carabelas (2005) 185 vi

9 Contents vii Australian Securities and Investments Commission v. Adler & Ors (2002 and 2003) 189 Duty of care 193 Business judgment rule 199 Other statutory duties 201 Australian Securities and Investments Commission v. Plymin & Ors (2003) (the Elliott case) 203 Brunninghausen v. Glavanics (1999) 208 Chew v. R (1991) 210 Circle Petroleum (Queensland) Pty Ltd v. Greenslade (1998) 211 Commonwealth Bank of Australia v. Friedrich & Ors (1991) 213 Cummings & Anor v. Claremont Petroleum NL (1993) 214 Darvall v. North Sydney Brick & Tile Co Ltd (No 2) (1977) 215 Paul Davies Pty Ltd (in liquidation) v. Davies & Anor (1983) 216 Fexuto Pty Ltd v. Bosnjak Holdings Pty Ltd & Ors (2001) 217 Geneva Finance Ltd (Receiver and Manager Appointed) v. Resource Industry Ltd & Anor (2002) 218 Guinness plc v. Saunders & Anor (1990) 222 Mesenberg v. Cord Industrial Recruiters Pty Ltd & Ors (1996) 223 Metropolitan Fire Systems Pty Ltd v. Miller & Ors (1997) 223 Morley v. Statewide Tobacco Services Ltd (2002) 228 Pacifica Shipping Co v. Anderson (1985) 230 Pascoe Ltd (in liquidation) v. Lucas (1998) 230 Pascoe s case on Appeal (1999) 231 R v. Byrnes (1995) 232 Re Polyresins Pty Ltd (1998) 234 Re George Raymond Pty Ltd; Salter v. Gilbertson (2000) 235 The Itoman reorganisation 236 Uncommercial loans 237 The share swap 238 Re Spargos Mining NL (1990) 241 Sheehan (as liquidator of South Australian Service Stations) v. Verco and Hodge (2001) 242 Southern Cross Interiors Pty Ltd (in liquidation) & Anor v. Deputy Commissioner of Taxation & Ors (2001) 245 State Bank of South Australia v. Marcus Clark (1996) 250 Wambo Mining Corporation Pty Ltd v. Wall Street (Holding) Pty Ltd (1998) 251 On-the-spot fines and directors liability 252 vii

10 viii Duties and Responsibilities of Directors and Officers Appendix Care and diligence civil obligation only Good faith civil obligations Directors of wholly-owned subsidiaries Reliance on information or advice provided by others Responsibility for actions of delegate D Delegation F Right of access to company books A Indemnification and exemption of officer or auditor B Insurance premiums for certain liabilities of director, secretary, other officer or auditor K Alternate directors 262 Case references 263 viii

11 Preface This work covers the most important aspects of a director s duties and responsibilities. Directors can take four positive steps to protect their position and that of their company. First, appoint properly qualified officers and advisers. Second, ensure that not only their own knowledge is kept up to date, but also that the knowledge of everyone else in the company who is responsible for this area is kept up to date. Third, implement a proper risk management program and compliance program. Fourth, take out adequate insurance cover for directors and colleagues despite the fact that the insurance cover may be limited in operation. Since the Commonwealth Criminal Code became part of our law in 2001, compliance by companies must now become an essential feature of their operations. There is a presumption of guilt if companies do not employ a culture of compliance when prosecutions are brought in for certain Commonwealth legislation. The existence of such a culture may also lead to lower penalties being sought by the relevant regulators or imposed by the court. The states and territories are likely to implement similar legislation in the not too distant future to deal with this area of the law. The Australian Institute of Company Directors encourages the adoption of such a culture of compliance. Members of AICD and readers of this work are well advised to ensure that they and their organisations take whatever steps are necessary to ensure that they are as up-to-date as possible in dealing with these areas of the law. Professor Robert Baxt Partner Freehills ix

12 Key terms ACCC Act AICD APRA ASC ASIC ASX CAMAC CASAC CL CLERP CLERP Act CLRA CJ Australian Competition and Consumer Commission (the regulator responsible for administering the Trade Practices Act) Corporations Act 2001 (Cwlth) Australian Institute of Company Directors Australian Prudential Regulation Authority Australian Securities Commission (the former regulator for the Corporations Law in Australia) Australian Securities and Investments Commission now the major regulator not only for the Corporations Law, but also for aspects of the insurance and superannuation industry. The responsible minister is the Minister for Financial Services. Australian Stock Exchange Corporations and Markets Advisory Committee. See CASAC Companies and Securities Advisory Committee. From March 2002 CAMAC Corporations Law Corporate Law Economic Reform Program Corporate Law Economic Reform Program Act Company Law Review Act Chief Justice

13 Key Terms xi Employee Entitlements Act FSR Act J NCSC P Privy Council RBA Corporations Law Amendment (Employee Entitlements) Act Financial Services Reform Act Justice National Companies and Securities Commission President A United Kingdom court of appeal to which cases from countries in the Commonwealth could be referred. Australia no longer has that access, as New Zealand does, but the decisions of the Privy Council are relevant to Australia as they form part of the common law. Reserve Bank of Australia

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15 Chapter 1 Introduction In this work I refer to the Corporations Act 2001 (Cwlth) as the Act. This is basically Commonwealth law, but because of constitutional difficulties faced by the Commonwealth Government the legislation is a combination of Commonwealth, and state and territory legislation with a reference by the states and territories of certain powers (see below). The work refers to either a corporation or a company interchangeably. The other source of law that is important in understanding Australian company law generally is the common law (or the general law). The Australian Stock Exchange s (ASX) Listing Rules and Business Rules play an increasingly important role in this area of the law because of a specific provision of the Act (s. 793C), which provides that the ASX Listing Rules and Business Rules should be treated as though they are part of the Act. The ASX also plays a complementary role as a regulator side-by-side with the main regulator in this area. This main regulator is the Australian Securities and Investments Commission (ASIC). Other regulators are the Australian Competition and Consumer Commission (ACCC), the Australian Prudential Regulation Authority (APRA), and in certain circumstances the Reserve Bank of Australia (RBA). At times, these regulators work together to implement reform or to administer the Act. This work, written primarily for directors and officers of companies, provides an overview of the major responsibilities and duties imposed upon directors and officers in carrying out their role. Some of these duties and responsibilities are derived from the national statute in operation the Act. This overriding Commonwealth legislation became increasingly important because of the Wakim litigation (Re Wakim; Ex parte McNally (1999)). In that case, the High Court of Australia held that the national corporations law scheme then in force was 1

16 2 Duties and Responsibilities of Directors and Officers unconstitutional. It was found in that case by a 6:1 majority that the states did not have the power to confer certain jurisdiction on the Federal Court, as the various state Jurisdiction of Courts (Cross-Vesting) Acts and various versions of the Act (Corporations Laws) purported to do. To overcome this difficulty the states and the territories agreed to confer certain powers on the Commonwealth, resulting in the enactment of the Act in While Parliament sought minimal change to the numbering of sections, where there is a significant change it is noted. Some duties and responsibilities derive from common law, the body of precedent developed as judges interpret previous cases in Australia, and increasingly from overseas (especially the UK). This work discusses the operation of the relevant rules (statutory and common law) as they affect directors, although most of the rules also apply to officers. Where there is a distinction of importance, it is noted. As well as the rules of company law, directors and officers need to be aware that a range of other rules (and this is an increasing range of rules) affect their obligations as directors and officers of companies. These other rules include responsibilities under the trade practices legislation, environment protection law, occupational health and safety law, equal opportunity law, taxation law, and the privacy principles that came into effect in The Commonwealth Criminal Code 2001 (Cwlth), which came into effect on 15 December 2001, places a premium on compliance. Risk management and corporate compliance are now central features of the organisation of a company and of compliance by its directors and officers. Failing to ensure that the company complies strictly with laws in these and other areas may have far-reaching ramifications for company directors and officers. The Act is the fundamental statute referred to in this work. The duties and responsibilities apply to public and private (proprietary) companies. A new form of company, the one person or one-director one-shareholder company introduced by

17 Introduction 3 the Corporations Law Simplification Act of 1995 (Cwlth), provides more flexibility for small businesses. Other measures intended to simplify the earlier legislation have been enacted from time to time. The Company Law Review Act 1998 (Cwlth) (CLRA) that came into effect on 1 July 1998 was a rewrite of the Second Corporate Law Simplification Bill. The simplification program was replaced by the Corporate Law Economic Reform Program Act 1999 (Cwlth) (the CLERP Act). This is aimed not only at simplifying Australian company law, or corporate law as it is sometimes referred to, and the relevant statutes, but also at ensuring that Australian company law is appropriate for Australia s position in the Asia-Pacific region. A number of initiatives pursued by the Federal Government led to a significant recasting of rules about directors in the CLERP Act. This introduced a statutory business judgment rule, rewrote some of the provisions on directors duties, introduced a new statutory right of action for shareholders (members), which overcame rules that had previously limited their ability to enforce claims either against directors and the company or against outsiders, in part revolutionised the rules on takeovers and fundraising, and clarified some issues about accounting standards and the rules generated by accounting bodies. In keeping with the policy of CLERP 6, the Financial Services Reform Act 2001 (Cwlth) (the FSR Act) introduced standardised regulation for all people and companies that deal in financial products, or that give investment advice. The FSR Act creates a single licensing regime for financial sales, advice and dealings on financial products, consistent and comparable financial product disclosure, and a single authorisation procedure for financial exchanges and clearing and settlement facilities. It has been heavily criticised and attempts are currently afoot to simplify its operations. What is genuinely hoped to be the final chapter of law reform came with the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (Cwlth) (CLERP 9). It introduced a number of changes in the areas of continuous

18 4 Duties and Responsibilities of Directors and Officers disclosure, auditor independence, the right of shareholders to obtain information about directors remuneration, and a number of other important changes on whistleblowing. Some of these changes are referred to later in this work. As we go to press the Corporations and Markets Advisory Committee (CAMAC) is in the midst of the third of three very important studies that it is undertaking on directors and their obligations and rights. Two discussion papers have been issued by CAMAC on Personal Liability for Corporate Fault and Corporate Duties Below Board Level and a third paper is being prepared by it on the proposal that the law might be changed to include a duty on the part of directors to take into account social responsibilities. The Parliamentary Joint Committee on Corporations and Financial Services (the PJC) is also examining this issue, which may result in new legislation either permitting or requiring directors to take into account broader interests other than the interests of shareholders (the current law). All of this is discussed in more detail later in this work. It is not possible here to discuss or to list every single duty or obligation faced by the company director. Many are technical in nature or are concerned with matters, such as the proper keeping of accounts and other records, and the filing of information with ASIC, formerly known as Australian Securities Commission (ASC), because of the implementation of the Wallis Report (1997). ASIC is responsible for corporate law and for certain aspects of the insurance and superannuation fields. It has also taken the role of regulating consumer protection laws, a duty previously the domain of the ACCC. Many technical areas of corporate law covered by the Act, by the common law, and by the various rules of the ASX, are not specifically covered in this work. Directors and officers should seek expert advice from lawyers, accountants, or stockbrokers in certain circumstances, irrespective of the companies from which they come; a large public company, or a small one-person company, now permitted.

19 Introduction 5 Company law is constantly the subject of review by the courts and by the parliament. As important decisions are handed down by the courts, they are noted in Law Reporter, published in Company Director 1. Directors should be aware that these discussions are limited in nature and, wherever possible, they should seek expert advice. For directors who wish to obtain a more detailed knowledge of all aspects of this area of the law, and its application, AICD conducts the Company Directors Course. In addition to the Act, there are various texts in this area, and AICD provides a series of other useful publications. 1. Company Director is the journal of the Australian Institute of Company Directors.

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21 Chapter 2 The company and its components 1 The structure of a company For our purposes a company is one incorporated under the Act or registered under preceding State or Territory Companies Codes. The Act refers to a company as a corporation. This is to ensure that as much weight as possible is given to the powers of the Commonwealth in dealing with trading and financial corporations, the subject of the Commonwealth s general power. This work refers to the corporation or the company as the or a company. (i) Public or private company A company may be public or proprietary (private). A public company has an unlimited number of members and may be listed on the ASX. A private, or as it is referred to in the Act, a proprietary company, is restricted to 50 members and has certain other restrictions imposed on its operations: it may not buy or sell shares from the public, it must restrict transfer of its shares, and its directors must comply with certain rules about disclosure that do not apply to directors of public companies, which are subject to more stringent requirements. An exempt proprietary company is a private company in which no shares are held by a public company. In addition the First Corporate Law Simplification Act introduced a new form of company: the one-person, one-director/oneshareholder company. Following the enactment of the First Corporate Law Simplification Act, the distinction between exempt and non-exempt proprietary companies has been replaced with a distinction between small and large proprietary companies. 7

22 8 Duties and Responsibilities of Directors and Officers A small company must meet at least two of the following criteria: consolidated gross operating revenue for the company and any controlled entities of below A$10 million annually consolidated gross assets of below A$5 million at the end of a financial year the company and the entities it controls have less than 50 employees at the end of the financial year. (ii) Limited or guarantee company A company may be limited by shares or by guarantee. Companies limited by guarantee are usually not-for-profit. A company may elect not to limit the liability of its members; the unlimited liability company can be formed where the arrangement is basically one of partnership. 2 Parts of a company The law considers a company to have three distinct elements, the: company itself, a separate legal person or entity directors and officers of the company. The directors normally act through a board of directors and certain officers may also be appointed directors shareholders or members of the company. The shareholders (or members) own the company, but the directors control the way in which the company operates. Increasing attention is being given to the role of shareholders especially because of the CLERP 9 reforms. (i) Number of shareholders The Act requires companies to have a minimum number of shareholders although with the new one-person company or the small business enterprise as it is referred to in the legislation, only

23 The Company and Its Components 9 one shareholder/member is required. A public company must have at least five shareholders, while the proprietary company must have two. If a company is a holding company, that is, it owns all the shares in a company or a subsidiary beneath it, providing the subsidiary is wholly owned, meaning that all its shares are owned by the holding company, the holding company is the sole shareholder in the subsidiary. (ii) Number of directors The directors are normally appointed by the shareholders. The company s constitution usually vests directors with significant power to manage the affairs of the company on behalf of the shareholders. A public company must have at least three directors, while a proprietary company must have two. The new one-person company only needs one director. Directors must be natural persons and do not have to have any specific academic or other qualifications. The Act and the general law are silent on this aspect, although there are tough rules about disqualification of directors in the Act (discussed later in this chapter). APRA is campaigning to introduce rules requiring certain qualifications to be applicable to directors of companies under APRA s supervision (for example, banks and other financial institutions). The business community vigorously continues to question the need for the changes proposed by APRA. While this has led to some success the eventual result of this initiative on the part of APRA is still unknown. 3 The company as a separate entity or person Once the company is formed through a formal process requiring the lodgment of appropriate documents with ASIC, the company is treated by the Act and by the common law as a separate legal entity or person, separate from its members, directors, creditors or employees. Because of the CLRA, a new company no longer has to have a memorandum and articles of

24 10 Duties and Responsibilities of Directors and Officers association. Rather, the company will have a constitution and what are known as replaceable rules. The constitution is the parallel document to the memorandum of association and the replaceable rules reflect much of the framework of the articles of association as they used to operate. Companies formed before the enactment of CLRA can retain their memorandum and articles and can amend them in the same way as under previous legislation. The courts have remained reluctant to look behind the formal structure of a company and to undertake the exercise of lifting the corporate veil, as it is referred to in the cases. The Act and the general law increasingly require that the courts have power to look behind the corporate veil. The courts can then see who the true owners of the company are especially in a small company or in other circumstances where it may be necessary to look behind the artificial entity, at the natural persons who are involved. This is happening more in areas of taxation law, trade practices law, and environmental law. It has been occurring with more frequency in the area of company law generally, where, under the insolvent trading provisions, directors are made personally liable for the debts incurred by companies. Because of the James Hardie affair, discussed briefly later in this chapter, there is now more attention being placed on the question of whether the corporate veil should be lifted in other cases involving claims in tort (negligence, and so on). Subject to these legislative directions and developments to the contrary, even if a company is a wholly-owned subsidiary the courts will still treat the two companies as separate legal entities. A British court endorsed this in the case of Re Polly Peck International plc (1996) as did the New South Wales Court of Appeal in Wimborne & Ors v. Brien (1997). There is a need to ensure that the separate legal entity of the company continues to be recognised (as it is little more than 100 years since the classic decision of Salomon v. Salomon & Co Ltd (1897). It is also important that this principle is not ignored or given up. A fundamental and important basis of our modern

25 The Company and Its Components 11 company law has allowed much of the commerce to develop in the common law world. This includes England, the United States of America, Australia, New Zealand, Canada, and a number of other countries. 4 The Salomon case In the Salomon case the House of Lords confirmed that a company was a separate legal entity and that the courts could not generally ignore the existence of the company, or to put it another way, could not look behind the company to make individuals responsible for the debts of the company. There has been increasing discussion of the exceptions to the rule in Salomon. Some of them are discussed in detail later. For commercial reasons it is important that the corporate group should be regarded as a single commercial entity, but the concept of limited liability must remain a critical and fundamental factor of our law. In this context, it is important to note that more judges, in not only Australia, but also elsewhere, treat the economic position of the company as critical in examining disputes that are brought before the court. This may require the court to determine who the true owners of the company are, where the funds of the company belong, who should be responsible for certain actions, or whether people should be able to seek recovery from different companies within a corporate group. It is also becoming even more important for our taxation laws and new initiatives are being developed in this area. It is relevant where the company is being sued and has no assets, or is heading towards bankruptcy. However, when the economic position is examined, other companies or people standing behind it would have the resources to meet the alleged claim for damages, or for whatever claims there might be. In Maronis Holdings Ltd v. Nippon Credit Australia Pty Ltd (2001), Bryson J, while sympathetic to the proposition that directors should be able to treat companies within the group as an economic entity for the purposes of financial planning, held that when it came down to legal issues