Guidelines for Directors of wholly-owned subsidiary companies March 2014
Introduction These guidelines summarise the basic legal and regulatory framework for directors of wholly-owned subsidiaries. The guidelines also provide some context to the role and responsibilities which arise when an employee of a parent company or other group entity is appointed as a director of one of the parent company s subsidiary entities. The guidelines provide practical guidance to help directors understand and meet their responsibilities as a director of a subsidiary company. This guide covers the responsibilities of wholly-owned subsidiaries with a primary focus on operating entities. A helpful way to think about subsidiaries is to assess the risk profile and consider whether the entity is one which: operates physical assets, such as manufacturing sites, and/or employs people and/or, trades in goods or services with external parties, or acts only as a holding company. Each type of entity will have a differing risk profile and each corporate group should form its own view on what is appropriate for directors in the circumstances of each entity. Non-operating entities, such as holding companies, may have lower risk profiles and directors of those entities may not need to take all of the actions which are recommended in these guidelines. Nonetheless, all directors have legal duties and should not regard being appointed to the board of a subsidiary company as an honorary position. Subsidiary companies may be established or acquired for a variety of reasons. There may be legal or regulatory requirements or particular tax or other advantages to establishing a subsidiary company. Although not all areas covered in these guidelines may be relevant to directors of all subsidiary companies, (for example non-operating subsidiary entities), directors should be aware that it is their responsibility to ensure that they understand all of their legal obligations as a director. While these guidelines attempt to summarise the more important obligations that generally apply to directors, it does not set out all of the different legal obligations that might apply. These obligations vary across industries, sectors and the different jurisdictions in which each subsidiary company operates. These obligations may also be in addition to any other jurisdiction-specific regulatory obligations that might apply. Directors should be aware that they may be held liable for the subsidiary s breach of obligations in a variety of legal and operational areas. Directors should also appreciate that there may be penalties involved for a failure to meet their directors duties and obligations as required by law. 2
The roles, duties and obligations of the director of a wholly-owned subsidiary Generally, the role of a director is to oversee the management of the company on behalf of its shareholders. The power to manage the company is given to the directors by the company s constitution, articles of association or by-laws (constitution). For wholly-owned subsidiaries, the shareholders are one or more other companies which might form part of the corporate group. This structure may be very different to that of the parent company which, if a publicly listed entity, may have thousands of external shareholders. As noted above, subsidiaries may also be created for many reasons, one of which might be to execute the strategies of the broader corporate group, with some executives of the corporate group appointed as directors of the subsidiary entity. Regardless, subsidiary company directors must perform their roles in compliance with all of their legal obligations. This requires directors to be active and diligent in performing their roles, and not simply acting as a rubber stamp ratifying the decisions of others. Directors owe a number of duties and obligations. These duties may vary across the different jurisdictions in which the parent company has subsidiaries, but can generally be summarised as follows: the duty to act in good faith the duty to exercise skill and care, and the duty not to trade while insolvent. The duty to act in good faith The duty to act in good faith requires directors to make decisions in the best interests of the company and for a proper purpose. Directors must: always act in good faith in the best interests of the company act honestly and make decisions for a proper purpose not abuse their position or seek to profit personally from it not use the company s information for personal gain or in a way that could harm the company, and avoid conflicts of interest wherever possible, and disclose all conflicts if they have any. Directors should also be mindful that the best interests of the subsidiary company might be different from the best interests of the parent company or corporate group. Generally, acting in the best interests of the company will often align with the best interests of its shareholders. When making decisions that are in the best interests of the parent company and wider corporate group, directors must satisfy themselves that the decision is also in the best interests of the subsidiary company. For example, is there a corporate benefit to the subsidiary company where the subsidiary gives a guarantee for a parent company? The benefit to the subsidiary company should be clear. The Corporations Act allows a company s constitution to include a provision to assist with subsidiary director duties (s 187). The Corporations Act provides that the directors of a wholly-owned subsidiary can be taken to be acting in the best interests of the subsidiary if: the constitution of the subsidiary company expressly authorises the director to act in the best interests of the parent company, the director acts in good faith in the best interests of the parent company, and the subsidiary is not insolvent at the time of the director s acts and does not become insolvent because of the director s acts. Directors are encouraged to read the subsidiary s constitution to see if this provision has been included or not. A director may have a conflict of interest not only because of the director s own interests, but because of the interests of others such as immediate family members (for example, spouse, parents, or children) and any companies of which they are also directors, or companies in which they have a significant interest (for example, a family company). All conflicts of interest must be disclosed and there are special rules that apply if a director has a material personal interest in a matter that relates to the affairs of the subsidiary (s 191 Corporations Act). It is important to get advice on any conflicts that may exist to make sure that they are managed appropriately. 3
Tips on duty to act in good faith Some ways in which you can demonstrate that you have acted in good faith might include: recognising that there is a conflict of interest where you, your direct family members or a company you control has business dealings with the corporate group. In such instances you should disclose your interest in writing to the corporate group company secretary or equivalent. If you are in any doubt about an interest you have, you should err on the side of caution and disclose it making appropriate disclosures and not participating in board discussions where you, your direct family members or a company you control stands to gain from a proposed transaction the directors are considering. This should be recorded in the minutes satisfying yourself that a potential transaction that affects the company is in the company s best interests. In such instances you should not approve the transaction if you are not comfortable with it, and you may wish to seek supporting information if necessary. Ask yourself whether you would approve the transaction if you owned the company ensuring that you always act in the company s best interests, and never put your own interests ahead of the companies interests. Never act in a way that harms the company ensuring that you do not reveal confidential information about the company to anybody if you don t need to, or if you think they might use it to harm the company, or acting honestly in all matters, and considering, if in doubt, asking yourself how you would feel if your actions were reported on the front page of a newspaper. 4
The duty to exercise skill and care The duty to exercise skill and care requires each director to take care and be proactive in performing their role. Directors must: act diligently and with reasonable skill and care perform their role to the best of their ability based on their knowledge and experience familiarise themselves with the company and its activities, and monitor the company s financial and commercial performance. Directors are expected to perform their role with a degree of diligence that a reasonable person in a similar position would exercise in similar circumstances. This will depend on the size and activities of the company. It is not acceptable for directors to act simply as a rubber stamp, or to be treated as such. When considering a potential transaction involving the company, directors must apply their own special skills and knowledge and exercise independent judgment. They must satisfy themselves that the transaction is in the best interests of the company, which may be different to the interests of the parent company or broader corporate group. If a director is not satisfied with the level of information or assurance provided, they should refuse to make a decision on the matter until appropriate information is available. Directors must understand the company and its activities and actively monitor its performance. One of the challenges for subsidiary company directors is that decisions affecting the company can be taken by managers who do not report to the directors and do not necessarily inform them of their decisions. Directors are not expected to make a detailed inspection of the company s day-to-day activities but must monitor them generally, and ensure that there are processes in place that allow them to appropriately monitor the ongoing activities. Tips on duty to exercise skill and care Some ways in which you can demonstrate that you have exercised skill and care might include: asking upon your appointment as a director for information about the company, including: about its activities and assets what the risks are that you need to focus on as a director the most recent accounts, including a balance sheet, profit and loss statement and cashflow statement to assess the solvency and financial strength of the entity, and the legal structure, constitution, shareholders, country of incorporation, other directors, key assets and liabilities etc. reviewing regular operational reports monitoring the company s financial performance and position, including asking for copies of the company s management accounts, where appropriate to be provided on a regular basis, and at least annually reviewing and assessing the material contracts the company has entered into, and understanding the contract approval request process satisfying yourself that the company has appropriate processes in place to manage risks and report its performance and position, and ensuring that your knowledge of the company and its activities remains current. 5
The duty not to trade while insolvent The duty not to trade while insolvent is a specific requirement which is usually classified as a subset of the duty to exercise care and skill, because it requires directors to turn their minds and apply their skills to assessing the financial position of the subsidiary. A company is considered insolvent if it cannot pay its debts when they fall due. If a company becomes insolvent and continues to trade, the directors can be held personally liable for debts incurred. To protect themselves, and meet their obligations, directors should satisfy themselves at all times that the company is able to pay its debts as they fall due. This is usually straightforward for holding companies that do not trade, but for trading companies it requires diligent monitoring. In Australia, directors are required to make a declaration that the company is solvent at least once each year. Directors should not make a solvency declaration until they have made proper inquiries and satisfied themselves that the company is indeed solvent. The company must keep adequate financial records to correctly record and explain transactions and the company s financial position and performance. A director who fails to take all reasonable steps to ensure that the company fulfills this requirement may be in breach of their directors duties. Tips on the duty not to trade while insolvent Some ways in which you can demonstrate that you have exercised skill and care to ensure that the entity is not trading while insolvent might include: monitoring the company s assets and liabilities, in particular its current (liquid) assets and current (short-term) liabilities, and finding out when its debts are due for repayment, especially any large debts finding out whether the company s liabilities are guaranteed by other companies in the corporate group, or vice versa. This might include, for example, a deed of cross-guarantee finding out if the company receives funding support (debt or equity) from other companies in the corporate group and the basis of that funding seeking a letter of support from the parent company or other entity in the corporate group, or taking immediate action to prevent the company trading while insolvent, where the entity is not able to pay its debts as they fall due. This might include seeking financial support from the parent company, or ceasing all trading activity. Directors should also immediately notify the relevant financial and legal officers of the corporate group and parent company. 6
What the board of directors of a subsidiary does The role of the board of the subsidiary company is to provide oversight. The directors, who are the board members, exercise their duties when they participate in the board to oversee the operation and strategic direction of the company. The directors are not responsible for the day-to-day operations of the company and should bear in mind that the considerations applying to a director role are different to those of management. Nonetheless, directors should understand both the operations of the company, and the areas in which they will be required to participate in board decision-making, as well as understanding the governance processes and practices by which directors exercise their powers. As noted above, subsidiary entities may be created for many purposes and operate in many different ways. What each board does, therefore, in each case will be different, and the operational aspects set out below may not be applicable to all directors. There may not be a board charter or terms of reference, which sets out how the board operates, and it is unusual for the company constitution to set out how the board operates. Directors will need to ask questions to understand the role of the board and how it exercises its powers. Transactions Directors are charged with monitoring and approving transactions having a material or major impact on a subsidiary company. Such transactions should be approved by the company s directors before they can be entered into. The parent company s delegated authorities may give managers authority to approve transactions, subject to a requirement that any transaction with a material or major impact on a subsidiary must be approved by the subsidiary company s directors before it can proceed. Details of delegated authorities are usually captured in the corporate group s delegations policy. However, a group s delegations of authority may not provide clarity on whether the directors of a subsidiary company have a right to approve major transactions. In such cases, directors should seek clarification from the owner of the group delegations policy. A failure to consider important transactions undertaken by the subsidiary company could potentially place directors in breach of their duty to exercise skill and care. The directors of the subsidiary need to have comfort about what will be treated as material. Matters to take into account include whether the transaction would: change the company s annual profit, assets or liabilities by amounts treated as material under the accounting standards cause the company to become insolvent, or cause the company to break the law or breach its contractual obligations. When evaluating a potential transaction, directors should carefully and objectively decide whether it is in the company s best interests. (See the duty to act in good faith above). Directors should also monitor the contracts entered into by the company and understand their impacts. (See the duty to exercise skill and care above). Documents giving effect to transactions may be executed in a number of different ways, such as being signed by: two directors, or one director and the company secretary, any person authorised to sign the document on behalf of the company, or an attorney under a specific power of attorney. Directors should not sign or authorise execution of a document, or grant a power of attorney (see below) to execute it if they are not satisfied that the document has been through the right approval processes. Powers of attorney Sometimes it is necessary for a company to grant a power of attorney giving someone authority to do particular things on behalf of the company. If a power of attorney is required, the entity might consider putting some or all of the following processes in place, such as ensuring that the power of attorney: is reviewed and endorsed by a member of the legal team before it is signed is reviewed and approved by the directors of the relevant company is limited to specific acts, which are listed in the power of attorney does not allow the attorney to sub-delegate their power has a fixed duration and automatically expires if the attorney ceases to be an employee or representative of the parent company, and/or is sent to the relevant officer of the parent company or corporate group for recording in the register and safe keeping after it has been signed. Where a director is unsure of the extent or validity of a power of attorney, the director may wish to seek legal advice. 7
Financial statements Some subsidiary companies (for example, small proprietary companies) may not be required to produce audited financial statements while others (for example, large proprietary companies, public companies) may be required to do so by law. If audited financial statements are required, they must contain prescribed information, be prepared and audited a certain way, and be lodged with the regulator within a specified timeframe. In those circumstances, the directors are responsible for: reviewing the company s financial statements after they have been prepared and audited and before they are lodged ensuring the financial statements are accurate and comply with applicable regulatory requirements and accounting standards approving the financial statements at a meeting of directors (provided the directors are satisfied the financial statements comply with all applicable requirements), and ensuring the financial statements are lodged on time. Irrespective of whether the company is required to produce audited financial statements, all directors are responsible for: ensuring the company keeps proper accounting records, and monitoring the company s financial performance and position and its solvency. Directors might consider insisting that management accounts are prepared and provided to directors regularly (how often will depend on the company and its operations, although at least annually is advisable), to enable them to monitor the company s performance and meet their responsibilities. Tips on financial statements (where they are required): Some ways in which a director might wish to demonstrate that they have carried out their duties in relation to financial statements include: asking that draft financial statements are considered at a meeting of directors, and not by circular resolution, and asking that the meeting be attended by the internal person who prepared the financial statements and the external person who audited them, where appropriate seeking assurance from the auditor and relevant internal people that the financial statements: give a true and fair view of the company s performance and position are accurate and comply with the applicable accounting standards and regulatory requirements contain all of the necessary disclosures, and affirm the company s solvency and do not give rise to any concerns or problems considering the subsidiary s cashflows, its assets and liabilities, and when its debts fall due for payment, and satisfying yourself that the company is solvent satisfying yourself that the financial statements are accurate and give a true and fair view of the company s performance and position, and asking questions if you are unsure reading and considering closely any declarations required in respect of the financial statements and satisfying yourself that they are totally correct, and considering whether enough time, assurance and information has been provided for you to review the financial statements, and asking for more time to review, where necessary. 8
Dividends Dividends must be approved by the company s directors, who are responsible for ensuring that the company is able to pay the dividend. Before approving a dividend, directors should review the company s balance sheet and cashflows and satisfy themselves that: the company s assets exceeds its liabilities the payment of the dividend is fair and reasonable, and the payment of the dividend would not materially prejudice the company s ability to pay its creditors. Work, health and safety (WH&S) Directors of Australian companies have obligations in relation to Work Health & Safety which vary in detail depending on the jurisdiction. In those jurisdictions where the law has been harmonised, the company has a primary duty to ensure, so far as reasonably practicable, the health and safety of workers (whether or not they are employees), as well as an obligation to others. Directors must exercise due diligence to make sure that the company has a system of compliance and acts in accordance with its WH&S obligations. In addition, a list of specific obligations are imposed on directors (for example, acquiring a knowledge and understanding of work, health and safety matters and the operations of the company and associated hazards and risks). Directors are exposed to liability, including criminal liability if they fail to meet their obligations. It is important to get advice on the application of WH&S laws and obligations in the context of the specific company and its operations. Companies that are purely holding or trading companies may have lower exposure to WH&S risks than companies that conduct manufacturing operations and employ people. In essence, directors are responsible for ensuring that the company s WH&S practices are adequate. For companies that conduct operations or employ people, the risk of harm is usually much higher, and the directors of these companies should: ensure they understand the company s WH&S risks and processes satisfy themselves that the WH&S processes meet the parent company s standards and are appropriately resourced and functioning effectively, and monitor the company s WH&S performance and risks. Directors of holding and trading companies, or those that conduct operations and employ people, must satisfy themselves that there is a system of WH&S compliance in place. Directors should review the WH&S risks of the company to ensure that they are satisfied with the approach to managing those risks. Environmental matters Under Australian law, directors may be held personally liable for harm to the environment caused by the company. Directors are responsible for ensuring that the company s environmental practices are adequate, and that the company conducts operations in a way which does not breach their obligations. Some tips appear below to assist the directors of operating and employing companies to meet their responsibilities in relation to WH&S and environmental matters. Tips on WH&S and environmental matters: Some ways in which a director might wish to demonstrate that they have carried out their duties in relation to WH&S and environmental matters includes: visiting any operational sites and meeting with the WH&S and environmental managers to get an overview of the site s risks, performance and processes asking for and reading copies of any site s regular WH&S and environmental reports and any recent audit reports joining the mailing list for WH&S updates from operational sites, or ensuring that information about WH&S or environmental incidents are appropriately collected, addressed and actioned, including making sure that remedial actions are implemented in a timely manner. 9
How the board of directors exercises its powers The board of directors of a subsidiary company may act in different ways depending on the authority provided by the constitution of the company, the board charter or terms of reference, and the company s activities. Directors should be aware, before they are appointed, of the particular role which the board is expected to perform. Directors should read the subsidiary company s constitution, which will usually contain a clause detailing the level of control of the parent company; and the board s charter or terms of reference (if any) to better understand the way in which the board will exercise its powers. The limits of authority of the board of directors may not always be clear, however, it is important that the directors review the terms of the subsidiary company s constitution and delegated authorities to understand the terms of the powers provided to them. Appointment, resignation and access to documents Directors of subsidiaries generally hold office until they resign, are removed by the shareholder(s), or cease being employed by the group. Directors may resign at any time and are usually expected to resign upon ceasing to be employed by the corporate group or if asked to resign by the corporate group. Resignations should be in writing addressed to the secretary of the relevant company and copied to the parent company s company secretary. A proposed director may sometimes be asked for a signed and undated resignation before being appointed, and authority for a representative of the parent to complete it (that is, when needed). Indemnity and insurance The company s constitution might contain a provision under which the company indemnifies directors for liabilities they incur as a result of performing their role. The indemnity is generally limited to honest mistakes and does not apply if a director has acted dishonestly or to deliberately harm the company. It is also only of use to a director if the statutory contract under s 140 of the Corporations Act applies. Other limitations may also apply. Directors may seek further protection under a separate deed of indemnity, access and insurance with the company. Subsidiary directors may be covered by the parent company s directors and officers liability insurance policy (D&O policy). However, directors should note that this is not always the case, and that the coverage of some D&O policies may not extend to directors of subsidiaries. Directors may wish to seek advice or a separate endorsement on the extent of the D&O policy. The D&O policy usually protects directors financially if they are held personally liable for wrongful acts they commit as directors. It does not protect directors who have acted dishonestly, fraudulently, or in deliberate ignorance of the law. A director should get written confirmation from the company secretary that the director will be covered by this policy. If you have any questions about indemnity or the D&O policy, you should contact the parent company s general counsel or company secretary. Upon ceasing to be a director, the director should return all of the company s property. While directors are entitled to board papers, each board must form a view as to the circumstances in which directors will be permitted to retain board papers beyond the board meeting to which they relate. Companies need to seek legal advice and form their own view as to whether board papers that have been provided to a director become the property of the director or remain the property of the company, and what the company s obligations are regarding the retention of such documents particularly where they include any annotations. Where a former director and the company have entered into a deed of indemnity, access and insurance, the director will usually be provided, depending on the terms of the deed, with access to the company s documents and records relevant to their period of directorship. A director of a company may inspect the books of the company (other than its financial records) at all reasonable times for the purposes of a legal proceeding. This right continues for up to seven years after ceasing to be director. See Governance Institute of Australia s Good Governance Guide: Director and ex-director access to company information. 10
Operation of the board The company s constitution sets out the rules for how the company must operate. Directors should familiarise themselves with the constitution and must ensure that both they and the company comply with it at all times. The constitution might contain restrictions on directors powers in certain circumstances. Any change to the constitution requires approval of the company s shareholder(s), usually by a special majority and after the change has been recommended by the directors. Each subsidiary company, and its directors and employees, will usually be expected to comply with any other of the parent company s policies and other mandatory requirements (including a code of conduct), and operate under enterprise-wide frameworks (for example, the risk framework). Each subsidiary company may be asked to formally adopt the parent company s policies and delegated authorities, as amended from time to time. The directors will also be required to exercise their duties and obligations by voting on matters at board meetings. Decisions of directors may also take place by circular resolutions that record the decision and are signed by all directors without them having to meet (s 248A Corporations Act). Directors should check to see if such actions are allowed by the company s constitution. Important decisions such as major transactions and the audited financial statements should generally only be made at a meeting of directors. Minutes of directors meetings and circular resolutions must be prepared and stored safely by the company secretary. Directors should ensure that the minutes and resolutions are accurate and comply with regulatory requirements. Directors must notify the company secretary or relevant officer of any change in their name or home address. The subsidiary board may be required to meet at various intervals throughout the year at a pre-determined time and place for board meetings. These meetings will be advised by the company secretary in advance, and directors are usually expected to make themselves available for these meetings except in limited circumstances. Directors meetings are generally undertaken to ensure that directors continue to exercise their duties and obligations to the company and to provide oversight over the company and its activities. In advance of the subsidiary s board meeting, the company secretary will distribute to the director a copy of the agenda and papers for the meeting. Directors are expected to review and turn their minds to the content of the papers for the meeting. Directors should be aware, however, that annotations to the papers may require explanation, and that it is best practice for directors to return their papers to the company secretary at the conclusion of the meeting. The company secretary will then usually only retain one set of clean papers as a record of the meeting. 11
Summary It is important that directors are proactive and take their responsibilities seriously. They should always have regard to their responsibilities and legal obligations when acting as a director. Failure to comply with legal obligations could expose a director to personal liability. These guidelines provide a summary only. They do not set out all of the different legal obligations that apply for every company, which vary from country to country. Directors are responsible for familiarising themselves with these obligations. If directors need advice, or have any questions about their role as a director, they should contact a member of the legal team or the group company secretary or relevant officer. 12