Controlling the management of a company is in general vested with the board of directors, by the company’s constitution. Such an important power supplies the dishonest, lazy or incompetent directors, the choice of fraud or mismanagement of the company’s issues and income. With a view to protect the sufferers, mainly the shareholders, common law and statute law have been developed.
Duties of executives and non executives are distinct. The managing director will be employed on contract under which there is an express or implied term for exercising due care and expertise. The essential duties of directors relate to policy matters, specifically in respect of the bigger corporations. A difference is made out between the chairperson, whose main responsibility is to make selection of the matters that are to be placed before the board, making the company’s policy and promoting it.
Delegation of powers by the directors is a general aspect of corporate governance. If such delegation hinders the future discretionary exercise, it should be authorized. The delegation of powers should only relate to matters that can be properly carried out by the delegate. Directors can rely on the management to bring financial and other matters pertaining to the company to the attention of the board. During this process, believing the delegate will be unreasonable if the director has knowledge of such information as would make a prudent individual to refrain from relying on the delegate. No director can totally relinquish his responsibility by resorting to delegation.
Dundee joined the firm Tony, Sam and Sally (TSS), a Sydney based law firm, and became a junior partner in 1995. Tony declared that Dundee would be made a senior partner in the firm, within two years, if he could get a major client into the firm and also abstain from causing any harm to the firm during that period by way of indulging in disputes with the firm’s clients. In May 2006, Dundee obtained the clientele of Zenith Software Ltd (ZS), which was a very large company. However, in the same month Dundee had a major altercation with one of the firm’s major clients, which resulted in the departure of this client to some other firm. Accordingly, Tony, Sam and Sally decided to postpone Dundee’s appointment as a senior partner indefinitely.
Dundee became disappointed with the firm and approached Milton Lawyers or ML by offering to get the ZS account if selected as a partner. This proposal was accepted by ML. Subsequently, Dundee sent an email to James, the managing director of ZS, if he was willing to transfer the ZS account to ML. Since, ZS had no objection, Dundee resigned from TSS and joined ML, and later on ZS transferred its files to ML.
Tony, Sam and Sally were of the opinion that Dundee had breached the fiduciary duties that he owed to the partners of the TSS. However, Dundee contended that it was James who had decided to transfer the ZS account to ML. Moreover, he alleged that the TSS had failed to implement the oral agreement that it had made to appoint him as a senior partner of the firm.
Based on the above facts, the main issue to be considered is whether Dundee’s resignation from TSS as a junior partner and joining ML as a partner constitutes a breach of his fiduciary duties, namely, to protect the interests of the company, to avoid a conflict of interest, duty of care and diligence. A claim against a director for breach of his equitable skill and care must include all the usual ingredients of a negligence claim.
The term director does not connote only an appointed person to the position of director but also any person acting as a director. It also includes a person, who is not appointed as a director but serves as a director of the company.
In addition to proving that the director was not discharging his duty with care and skill, the company must show a casual connection between the director’s breach of duty and the loss suffered by the company. It is now clear that in equity as at common law, liabilities are fault based, and therefore the director is liable only for the consequences of his breach of fiduciary duty and to make good the damage caused by his breach.
As such director’s duties are owed to the company, and therefore, in general terms the company is the person that one would expect to be primarily entitled to bring proceedings in respect of breaches of those duties.
Although, Dundee has resigned from TSS, he is still bound by his fiduciary duties, which are enforceable. In Canadian Aero Services Ltd v O’Malley it was held that fiduciary duties do not expire on termination or resignation.
In Spies v. The Queen it was held that Directors were not obliged to carry out an independent duty by virtue of their status. Moreover, this duty was not enforceable by the creditors of a company. Further, directors' duties are not, in the normal course, owed to individual shareholders; this was the decision in the cases of Brunninghausen v Glavanics and Southern Cross Mine Management Pty Ltd v Ensham Resources Pty Ltd. In Australian Metropolitan Life Assurance Co Ltd v Ure and Ascot Investments Pty Ltd v Harper it was opined by the court that the burden of proving that a director had improperly exercised the powers conferred upon him or that he had failed to properly discharge his duties lies with the person making the accusation. The duties of a director have been specified in the Corporations Act 2001.
Section 181 of the Corporations Act
There is a binding fiduciary relationship between the director and the company which demands the director shall be loyal by acting in good faith and in the best interests of the company. The director shall act on behalf of the company for correct corporate purposes and provide immense consideration to decision making process duly implementing fair judgements. These guidelines are further reiterated Section 181 of the Corporations Act. This section reinforces that the directors shall invariably discharge their duties and exercise powers in good faith in the interests of the corporation and for proper purpose. The principles of the common law are incorporated into this section in respect of director’s duties.
While examining any breach of section 181 as a matter of law the courts evaluate the exercise of power of director on purposes for which it is justifiable or not, and as a matter of fact the exercise of power for purpose which falls within the scope of permissible purposes.
The size and nature of the company also matters. Small company directors who are also the shareholders of the company are bestowed with wide-ranging powers than those of large public limited companies. The other area is the constitution of the company, the activities therein and the type of the company that are also taken for consideration. The court, while determining the question of fact, considers the subjective outlook of the directors and their justification towards matters of management. Situations where the court may face difficulty in determining the significant purpose of the majority directors when the presence of rebellious directors who deny to share the similar purpose. Thus there shall be a collective reason even though individual director’s statements differ.
The duty to act bonafide in the interests of the company can be found under section 181 of the Corporations Act 2001. To analyze whether Dundee had adhered to these requirements, his conduct while moving to ML has to be examined. In this process he had taken along with him one of the important clients of TSS. This indicates that he had breached his duty to act honestly in the interests of the company.
It is to be examined whether Dundee’s resignation absolves him from accountability to TSS. In Canadian Aero Services Ltd v O’Malley it was established that fiduciary duties are not extinguished on termination or resignation.
Therefore, Dundee is bound to honour his fiduciary duties towards TSS even after submitting his resignation. However, Dundee had given an email to James asking him whether he had any objection to shifting the ZS files to ML, while he was still working for TSS. Moreover, he did so because he had not been made a senior partner in TSS. Further, he had not been promoted, because he had fought with a valuable client and this had resulted in the departure of that client. Therefore, TSS had not done any injustice to him. This indicates that Dundee had behaved in a malafide manner.
Further, a company cannot be characterised as an agent of its shareholders unless there is clear evidence to show that the company in fact is acting as an agent of its shareholders in a particular transaction; and the property of a company does not belong to its shareholders. This concept that the company has a separate liability to its directors and its shareholders relates to a number of references including the company’s legal personality, the corporate veil and separate legal entity. Together these terms form a common idea that a company has a completely separate legal existence to its subscribers, shareholders, directors and company officers.
The term corporate veil connotes that incorporation of a company raises a separate legal liability in the company, from that of its directors and shareholders. A company is a separate legal entity from that of its directors and shareholders and has a separate and distinct liability from those directors and shareholders. In other words, the creditors cannot recover the debt from the directors directly, as they were unable to pierce the corporate veil.
In cases of certain breaches the courts will hesitate to review business judgments of directors by substituting their own judgments on merits. Some instances of the above include the permission accorded to a company to enter into non beneficial transactions; permitting unreasonably risky trading by a company; allowing the distribution to members of a notice of a meeting with several false statements; failure to verify the correctness of the financial data of a company and not participating in the regulation of the company's management. Moreover, the directors of a specialized professional trustee company might be bestowed with a much greater duty of care in comparison to a prudent person, as was decided in Wilkinson v Feldworth Financial Services Pty Ltd.
Dundee first joined LSS, which is a law firm. Subsequently, he resigned from LSS and joined ML, another competing law firm. The latter firm had appointed Dundee with the knowledge that he had breached fiduciary obligations owed to LSS. Dundee had contacted ML stating that he would bring a new and major client from LSS to ML if appointed.
If LSS is desirous of filing action against ML it has to prove that ML had knowledge that Dundee was breaching his fiduciary obligations towards LSS by bringing about a transfer of the account of ZS from LSS to ML.
Other civil obligations under the Corporations Act
The directors of a company are required to abstain from inappropriately utilizing their official status in order to obtain a benefit for themselves, some other person or causing a loss to the company, this is the provision contained in Section 182 of the Corporations Act.
In a similar manner, Section 183 of the Corporations Act prohibits a serving director or an erstwhile director from improperly utilizing information acquired during their tenure, with the motive of acquiring an advantage either for themselves, some other individual or cause a loss to the company. Most importantly, such duty persists even after the director’s retirement or resignation.
The proscriptions specified by section 182, section 183 and section 181 of the Corporations Act result from the fiduciary duty to avert differences that come to pass due to the personal interests of a director and the company's interest and the requirement “to act only in the best interests of the company. The concept improperly is assessed objectively.”
In the event of a loss caused to a company due to a director's unacceptable exercise of power, the director will attract joint and several liability, according to which he will have to recompense the company. The causation test attempts to determine whether loss would have taken place if a breach of duty had not taken place.
In the case of Gold Ribbon the causation issue that proved impossible for the company to prove in the long run, was whether imprudent loans had resulted from the director Dunn’s omissions and whether such loans would not have been disbursed by some other director. It was held that the mere possibility of there being an enhancement in the chance of an improper loan application being rejected if Dunn had discharged his duty properly, was insufficient to establish the required causal nexus between his breach of duty as a director and the company's loss.
Effect of civil breaches of directors' duties under the Corporations Act
Breaches under section 180, section 181, section 182 and section 183 of the Corporations Act attract civil penalties. A declaration of infringement under section 1317E of the Corporations Act, will give rise to penalties upto $ 200, 000 awarded by the court under section 1317G of the Corporations Act. section 1317S of the Corporations Act, states that a court may absolve a director of liability if the director can establish that he had acted in good faith.
Criminal breaches of directors' duties
According to section 184(1) of the Corporations Act directors are deemed to have committed a criminal offence if they had been negligent or deceitful and had evaded their duties to exercise their powers in good faith and in the best interests of the company. Section 184(2) of the Corporations Act provides that the director of a company is guilty of a criminal offence if he has utilized his official position in a dishonest fashion, with the objective of gaining an advantage or causing a loss to the company.
Section 184(3) of the Corporations Act, states that an individual who acquires information by virtue of being or having been a director commits an offence if he uses the information dishonestly, with the intention of wrongful gain or causing loss to the company, as a result of his position as a director, if he uses the information for wrongful gain or for causing a loss to the company or the misutilization of power results in either direct or indirect gain of an advantage or causes a loss to the company.
The High Court decisions of Campbells Cash and Carry Pty Limited v Fostif Pty Limited and Mobil Oil Australia Pty Limited v Trendlen Pty Limited, clarify the law in respect of representative proceedings that have been financed by litigation funders, in Australia. The outcome of these decisions could be that lawyers and judges would have a large and growing body of jurisprudence that examines the limits of directors' duties and would bring about more frequent, innovative and rigorous quest of directors who breach their fiduciary duties.
Dundee was a junior partner in TSS, as per the provisions of the Corporations Act he is holding fiduciary responsibilities with TSS even after his resignation. These fiduciary duties will continue even after he takes up employment with ML. Hence, he is bound by his fiduciary duties to TSS even after his resignation from TSS. Therefore, TSS can claim damages for the breach of fiduciary duties. Moreover, TSS can take legal action against ML by seeking an injunction from a court of law, restraining ML from appointing Dundee.
H A J Ford, R P Austin and I M Ramsay. Ford’s Principles of Corporation Law, Butterworths, Australia.
ASIC v Adler (2002) 168 FLR.
Ascot Investments Pty Ltd v Harper (1981) 148 CLR 337.
Australian Innovation Ltd v Petrovsky (1996) 14 ACLC 1357.
Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199.
Brunninghausen v Glavanics (1999) 46 NSWLR 538.
Campbells Cash and Carry Pty Limited v Fostif Pty Limited (2006) HCA 41, 30 August 2006.
Canadian Aero Services Ltd v O’Malley (1973) 40 DLR (3d) 371 at 382.
Circle Petroleum (Qld) Pty Ltd v Greenslade (1998) 16 ACLC 1577.
Daniels v Anderson (1995) 37 NSWLR.
Gold Ribbon (Accountants) Pty Ltd (in liq) v Sheers & Ors (2006) QCA 335.
Howard Smith Ltd v Ampol Petroleum Ltd (1974) AC 281.
Mobil Oil Australia Pty Limited v Trendlen Pty Limited (2006) HCA 42, 30 August 2006.
R v Byrnes (1995) 183 CLR 501.
Sheahan v Verco (2001) 79 SASR 109.
Spies v. The Queen (2001) 201 CLR 603.
Southern Cross Mine Management Pty Ltd v Ensham Resources Pty Ltd (2004) 2 Qd R 207.
Wilkinson v Feldworth Financial Services Pty Ltd (1998) 17 ACLC.
Corporations Act 2001 (Cth)
Peter Prince, Jerome Davidson and Susan Dudley, In the shadow of the corporate veil Research Note no. 12 (2004-05) Parliament of Australia <http://www.aph.gov.au/Library/pubs/rn/2004-05/05rn12.htm> at 16 January 2007.
 Canadian Aero Services Ltd v O’Malley (1973) 40 DLR (3d) 371 at 382.  (2001) 201 CLR 603.  (1999) 46 NSWLR 538.  (2004) 2 Qd R 207.  (1923) 33 CLR 199.  (1981) 148 CLR 337.  (1981) 148 CLR 337.  Corporations Act 2001 (Cth) Chapter 2D Part 2D.  H A J Ford, R P Austin and I M Ramsay. Ford’s Principles of Corporation Law, Butterworths, Australia, 2000, 8.010.  The section imposes two separate duties, the first in s 181(1)(a) and the second in s 181(1)(b).  Howard Smith Ltd v Ampol Petroleum Ltd (1974) AC  H A J Ford, R P Austin and I M Ramsay. Ford’s Principles of Corporation Law, Butterworths, Australia, 2000, 8.240.  Canadian Aero Services Ltd v O’Malley (1973) 40 DLR (3d) 371 at 382.  Peter Prince, Jerome Davidson and Susan Dudley, In the shadow of the corporate veil Research Note no. 12 (2004-05) Parliament of Australia <http://www.aph.gov.au/Library/pubs/rn/2004-05/05rn12.htm> at 16 January 2007.  ASIC v Adler (2002) 168 FLR.  Circle Petroleum (Qld) Pty Ltd v Greenslade (1998) 16 ACLC 1577.  Australian Innovation Ltd v Petrovsky (1996) 14 ACLC 1357.  Sheahan v Verco (2001) 79 SASR 109.  Daniels v Anderson (1995) 37 NSWLR.  (1998) 17 ACLC.  R v Byrnes (1995) 183 CLR 501, Brennan, Deane, Toohey and Gaudron JJ, 517.  Ford et al, above, 8.280.  Gold Ribbon (Accountants) Pty Ltd (in liq) v Sheers & Ors (2006) QCA 335;  Ibid.  (2006) HCA 41, 30 August 2006.  (2006) HCA 42, 30 August 2006.