Case analysis of directors’ duty
This part introduces the duty of director in general and the duty in relation to insolvent trading.
2.0 Analysis of directors’ duty
This part analyse directors’ duty with consideration of the facts in this case which is mainly about the duty to exercise reasonable care and diligence and for the best interest of the company.
3.0 Analysis of directors’ duty in relation to insolvent trading
This part analyse the duties of directors in relation to insolvent trading and the consequences and liabilities for breaching them..
This part is the conclusion based on the analysis of directors’ duties in this case.
Table of contents
1.0 Introduction ……………………………………………………………………3
2.0 Breach of directors’ duty and the consequences ………………………….….3
3.0 Directors’ duty and penalties in relation to insolvent trading and available defences………………………………………………………………………..……5
In the structure of a corporation, the board of director is granted the power and strength to manage the business and be responsible for the development of the whole corporation and shareholders in the end. Considering the powers entrusted in a director, who may abuse such power to sacrifice the interest of the company for his own, the duties of a director are laid down specifically in statutory law as well as common law. Under these duties, it is mandatory that directors should follow; otherwise he will be subjected to liabilities, both civil and criminal liabilities. As latest trend shows, directors are considered should take on stricter liabilities with regard to financial condition of the company, which include that they should be responsible for the authenticity of the financial report and to disclose them on a regular basis.
2.0 Breach of directors’ duty and the consequences
In Australia, the duty of directors in a company is laid down in statue and the common law. And they share similarities in certain way. According to corporate governance doctrine, a director is acting like agents for the shareholders who are the owners of the company. In this way, directors are to undertake fiduciary duties for the company. In line with the common law and the corporation Act 2001, the duties of a director include that they should act in the best interest of the company, to exercise care and due diligence , to act of a proper purpose , to avoid conflict of interest. Under these duties, it is believed that directors could use their strength and power to promote the development of the company and to boost the interests of shareholder. Failing to accomplish these duties brings with civil and criminal liabilities. Though in reality, the question of whether director fulfilled their duties is complicated and directors can use the business judgemental rule as defence.
In GHLM Trading Ltd v Maroo & Others , the court held that a director owes the duties to the company to act in a way that is to promote the success of the company, to exercise care and due diligence, to avoid conflict of interest and to disclose his interest in a transaction that the company is entered or about to entered into. If the duties are breached, the company is entitled to bring suit to the breaching director for the losses which are suffered by the company resulting from such breach. In this case, the court concluded that the directors breached their duty by selling the company’s stock and failing to disclose such actions to the shareholders in the company and the company shall be entitled to recovery its losses.
Section 180(1) of the corporation act defines that directors and other officers of the company all undertake the duty to act with care and due diligence which is expected to exercise by a reasonable person. In this respect, both executive and non executive directors are all under the general duty to act in the best interest of the company and to be diligent in exercising their duties, though the specific standard for them may be different. Generally, the duties for an executive director shall be heavier and detailed than a non-executive director as the former one undertakes the daily responsibilities to manage the company’s business. However, this does not imply that non executive directors are allowed to do nothing. They should also be involved in the management of the company and do their jobs.
William, who is the managing director of the Hampton Park Pty Ltd, breached his duty as a director. By assuring Jack that the company has the best chief financial officer, William was intending to let Jack stay out of his duty. As managing director, William should know that the job of Jack is to provide financial supervision to the company and his action actually breached this duty. And lacking the financial supervision would be detrimental to the development of HP which was manifested by later incidents. By doing this, William breached the duty to act with care and due diligence and to work for the best interest of the company. William breached his duty the managing director concerning the duty to maintain diligence in respect of financial report of the company. William should have known the daily management of the company and he should keep alert of the financial condition of the company. However, when the financial report was handed to him, William failed to notice the mistakes and false in the report and this ultimately led to insolvency of the company.
As is the regulation of the corporation act 2001, although non-executive directors’ duties are of an intermittent nature, they have a continuing obligation to read their company’s financial statement and know its financial position. In addition, non-executive directors may not be subjected to the same standard required on the part of executive director; they play an important role in the management of the company. And the breaches of their duties also lead to liabilities. In this case, Susan is the non executive of HP. And she has business with other companies. To avoid conflict of interest, she should disclose this interest to the company. Susan also bears the responsibility to act in the best interest of the company and to act with care and due diligence. According to this, Susan could not just leave the management of the company to other directors and do nothing because this constitutes breaches of the directors’ duty. The same condition exists with Jack who undertakes the job to provide financial supervision to the company but was talked out of it by William. However, this could not be the excuse for Jack. As Jack is experienced, he should know that he shall exercise due diligence to fulfil his duty instead of doing nothing and leave the company financially unsupervised.
George breached his duty as he failed his duty to maintain financial accounts. According to Section 286, the financial accounts of the company shall be in line with the real financial condition. The duty to prepare financial accounts rests with directors, which specifically in this case, on the shoulder of George. George, who knows the actual financial conditions of the company, should have told the accounts to make financial reports that were in line with the real condition of the company. But he told the accounts to do otherwise. And the false financial reports went unsupervised and got approved in the end by the board of directors. Also, he breached his duty when he found out that the changes in relation to the basis to declared dividends and failed to inform other directors. Under the financial condition of the company, it was impossible to declare dividends without subjecting the company into insolvency.
The consequences for breaching the duties of the directors include civil liabilities. Under the Corporation Act section 184, criminal liabilities would be resulted if it is found out that the director was reckless in fulfilling his duty or that he intentionally breached his duty. Therefore, in considering the specific facts of the case, it is possible that the directors shall undertake civil liabilities as their failure to discharge their duties led to the consequences of insolvency of the company. Jack, as can be seen from the case, intentionally or at least rather recklessly, breached his duty as the director in full charge of the company’s finance and he will have to undertake criminal responsibilities.
3.0 Directors’ duty and penalties in relation to insolvent trading and available defences
Director should act in the best interest of the company, which means that director should not do anything which may render the company insolvent as this is detrimental to the interests of the shareholders as a whole. Directors are required to manipulate all the powers granted by the company to let the business run and make profit. According to section 588G of the corporation act 2001, a director shall take on personal liabilities if he allows the company while being insolvent incur a debt, or the debt causes the company into insolvency. The basis for such personal liabilities is that when the insolvency happened, there should be reasonable ground for the directors to believe or suspect that insolvency will be incurred as the result of this. If the director was dishonest in his action to incur the debt or the failure to prevent the happening of insolvency was dishonest, criminal liability will be incurred.
According to the Corporation act 2001, dividend would only be declared when the company has a profit. However, in this case, George who was the chief financial officer of the company who knew that there was no profit for the company and deliberately told the accounts to falsify the financial reports. George may subject himself to criminal liabilities as from the facts in this case, he was dishonest. Firstly, he intentionally told the accounts to falsify the financial report. Later, he was dishonest in preventing the happening of insolvency by not give notice to the changes to other directors in time. Other directors breached their duties by not exercising care and due diligence in verified the financial report and approved the dividend. The declaration of dividends led to the company into liquidation and all the directors involved shall be responsible for the consequences. William, the managing director, breached the duty by telling Susan and Jack to not undertaking their responsibilities as directors. Also, he should be closely informed about the financial condition of the company and check whether the financial report provided by George was true or false. However, he did not, he relied totally on Jack instead of exercise due diligence. His breaches of his director’s duty contributed to the insolvency. Susan and Jack are also responsible. As the directors of the company, they should keep informed about the finance and other conditions of the company, but they did not. They should properly fulfil their duties and should be succeeding in detecting the mistakes in the financial report and prevented the company into liquidation. Thought from the surface, they lack reasonable ground or suspicion that the company would be insolvent by declaring dividends.
Section 588H of the corporation act indicates that the defence for directors include lack of reasonable ground that the action would lead to insolvency. As analysed in above paragraphs, this could not constitute defences for the directors. However, in respect of Susan, a defence would be raised as she was absent from the meeting to declare dividends. This means that Susan did not actively take part in making the decision which caused the company insolvent. The second defence for them would be that, the directors took all the reasonable efforts to prevent insolvency.
Breaching the duty in relation to insolvent trading may lead to civil liability. Section 137HA states that the company itself, the creditors, or liquidators can bring suit to the directors liable for the losses they suffered due to the actions of these directors. Section 588 states that compensation shall be paid to the parties thus suffered, or certain amount of fines or disqualification from the position as a director for certain amount of time. And also, the director shall be subjected to criminal liabilities under section 588G under the condition that he acted dishonestly in failing to prevent the company into insolvency. If a director is both civilly and criminally liable, he shall face a fine penalty or be disqualified from being a director in a company within certain period of time.
Directors undertake fiduciary duties. They should act in the best interest of the company and exercise reasonable care and diligence. Their roles and actions are quite important for the development of the company and the interest of shareholders as a whole. Thus all the directors should fulfil their duties and not to avoid them. Directors should be honest in discharging their duties. If not, they will be subjected to criminal liabilities.
In this case, William, Jack, Susan and George all breached their duties as directors in HP. William were the managing director. He breached his duty when he assured to Jack and Susan that they could stay out of the business and by failing to notice the falsifications in the financial report. Susan and Jack breached the directors’ duty because as director she hardly involved herself in the management of the company. George breached his duty because he intentionally falsified the financial report and failed to inform other directors the changes in law. The conclusion is that all the directors should take consequences for their actions, which including civil and criminal liabilities.
ASIC v Healey  FCA 717
Daniels & Ors v Anderson & Ors  13 ACLC 614
GHLM Trading Ltd v Maroo & Others  EWHC 61 (Ch)
Percival v Wright  2 Ch 401
Regal (Hastings) Ltd v Gulliver  UKHL 1
Dorchester Finance Co Ltd v Stebbing  BCLC 498
The Corporations Act 2001(AU)
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