Violation of Director Duties in Corporate Law

This case study discusses the violation of director duties in corporate law and the potential consequences. It examines the duties under the Corporations Act and relevant court judgments.

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Corporate Law

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Issue
The issue which is raised in this case is whether any director duties are violated by Lillian
and Gumpta while taking business decisions. Another issue is whether there are any possible
consequences of their conduct.
Rule
A corporation is referred as a separate legal entity which has a legal entity that is separate
from its members and directors. Due to this separation of the legal entity, the liability of the
members and directors is separate from the company, and they cannot be held personally
liable for its liabilities. These elements were recognised by the court in the ruling of Salomon
v Salomon & Co Ltd (1897) AC 22. It is a leading case in which the court established key
characteristics of companies. Salomon started a company in which he was a majority
shareholder along with few of his family members. He also had debentures of the company.
The corporation went into liquidation, and it was not able to make the payment to its
unsecured creditors. However, Salomon received money on his debentures. A suit was
brought against Salomon by the unsecured creditors of the company by claiming that he is the
majority shareholder; therefore, he should be held liable to make payment of the debts of the
unsecured creditors (Goulding 2013). They also claimed that the debentures are sham. The
House of Lords rejected these arguments and provided that Salomon cannot be held
personally liable.
The court provided that the information regarding debentures is included in documents of the
company based on which they are considered as valid. Although this judgement highlighted
that corporations are separate legal entities; however, this did not mean that the court cannot
hold the directors or shareholders liable for their actions if they misuse their position by using
the separate legal entity of the company. The court recognises that the company is not a
natural person and its directors take decisions for the company. While taking business
decisions, the directors have to ensure that they comply with various duties which are
recognised in the Corporations Act 2001 (Cth). These duties are included in the Act to ensure
that directors did not misuse the position in the corporation. They should not allow using the
separate legal entity to gain unfair advantage in the business. In Australia, the court has
provided various judgements in which the directors were held liable for violating the separate

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legal entity of the company such as ASIC v Vines (2005) 55 ACSR 617 and ASIC v Rich
(2003) 44 ACSR 341.
There are various general duties of directors which are recognised by the Corporations Act
which guides their actions to ensure that they misuse their position. The Act recognises a
fiduciary relationship between the company and its directors since they are responsible for
taking business decisions of the company. These duties are subjective in nature, and they are
recognised by the court based on the evaluation of the facts of the case (Lee & Fargher 2013).
Along with the statute, these duties are recognised in the common law as well. A good
example is the duty of care and diligence which is given under section 180 of the
Corporations Act. This duty is recognised based on the fiduciary relationship between the
parties. As per this duty, the directors have to ensure that they maintain a degree of care and
diligence while taking business decisions which is expected for a reasonable person who is
acting in a particular position. This duty cannot be eliminated by delegating the
responsibilities to third parties.
As per this duty, the directors should question the information put before them by others
rather than simply accepting such information while taking business decisions. Subsection (2)
of this Act provides that this duty should be maintained by the company to ensure that the
decisions are taking in good faith and the directors did not rely on material personal interest
while taking the judgement. This duty was recognised by the court in AWA Ltd v Daniels t/a
Deloitte Haskins & Sells & Ors (1992) 10 ACLC 933. In this case, the court provided that the
directors must put themselves into the position by taking appropriate steps to monitor the
management of the company. They must have general understanding regarding the operations
of the company and how the changing economy might affect their operations. Similar
judgements were given by the court by recognising director duties in ASIC v Adler [2002]
NSWSC 171, Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2 and ASIC v
Cassimatis (No 8) [2016] FCA 1023.
Section 181 provides that the directors have a duty to ensure that they act bona fide (in good
faith) while taking business interest to ensure that the interest of the company as a whole is
fulfilled. The court uses a subjective test while determining whether this duty is violated or
not be ensuring that the actions of the directors were honest and in good faith. In the case of R
v Byrnes and Hopwood (1995) 183 CLR 501, the court found that a director or office can still
be found in violation of section 181 of the Corporations Act even when the decision is taken

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while considering the benefit of the company but for an improper purpose. As per this rule,
the directors have to ensure that the interest of the company is recognised by the director
while taking business decisions. In case the transaction is taken while ensuring the interest of
the company, but it is considered illegal, then the director will still be held liable for violating
the duties given under section 181. Section 182 (1) of the Corporations Act provides that the
directors must avoid using their position for improper purposes.
Subsection 1 (a) of this act provides that they must not gain an advantage for themselves
while taking business decisions. Section 183 of the Corporations Act provides that the
directors must not misuse the information which they have for improper purposes. As per
their fiduciary duty, the directors should not abuse the confidential information which they
acquire as a result of their position. The information which is confidential and not available in
the public domain should not be missed by the directors to gain an unfair advantage or
causing harm to the corporation. This duty was recognised in the case of ASIC v Southcorp
Wines (2003) 203 ALR 627. In this case, the court provided the court must not contravene
continuous disclose rules by communicating to analyse before notifying ASIC under section
674 (2) of the Corporations Act. In the judgement of Howard Smith v Ampol Petroleum Ltd
[1974] AC 821, the court provided that the information which is available for the directors
must only be used “for proper purpose only”. It means that the best interest and propose
purpose must not be influenced by the personal opinions of the directors.
Section 588G of the Act also provides that the directors must not conduct trading while the
company is insolvent. Subsection (1) of the Corporations Act provides that the person who is
acting as the director of the company while incurring the debts of the can be held liable for
violating the duties given in the Act. The corporation must be insolvent at the time when the
debt is incurred. The director must be aware that the company is insolvent or it is likely to
become insolvent based on such decision. Commonwealth Bank of Australia v Friedrich
(1991) 5 ACSR 115 is a relevant case in order to understand this duty. In this case, the court
provided that the directors have violated section 588G (2) of the Corporations Act because
the loan given by the director was fraudulent and he should not have signed the annual
reports of the company while knowing that it includes assets which companies did not own.
In this case, section 588G (2) and (3) of the Act were violated (Keay 2014, p. 63). Section
588H provides various defences for the directors based on which they cannot be held liable
for insolvent trading.

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Subsection 4 of this section provides that if the director is unaware of the insolvency of a
company and did not take part in the decision process, then he/she cannot be held liable.
Moreover, section 1037A of the Act provides that the directors or other officers of the
company must not particular in insider trading where they use confidential information about
the company to purchase or sell shares. In R v Firns [2001] NSWCCA 191 case, the court
provided that directors can face legal penalties if they use the confidential information which
they have to purchase or sell shares of the company. A civil penalty is imposed on the
directors under section 1317J of the Act for violation of general duties. As per subsection (1)
of this section, the ASIC has the right to apply for a compensation order, declaration of the
contravention or pecuniary penalty order. In case the director violates the provisions given
under section 588G, then the director can be held liable for civil or criminal penalties or both.
Application
In the given case study, Lillian is acting as the director of All Mine Pty Ltd, and she realised
that the company needs more computer to run its operations. She orders computers worth
$100,000.00 from Greedyas Pty Ltd even after knowing that the financial condition of the
company was not good and this decision will lead to the insolvency of the company. Mr
Gumpta was the directors of Greedyas Pty Ltd, and he knew that the financial position of All
Mine Pty Ltd is not solid; however, he entered into the contract to meet his sales target.
Lillian and Gumpta have violated their duties given under section 180-183 of the
Corporations Act. They failed to maintain a standard of care and diligence which is expected
from them while operating in a particular position. Lillian knew that purchasing computer is
important; however, she did not consider the fact that it will lead to insolvency of the
company. As discussed in the judgement of AWA Ltd v Daniels t/a Deloitte Haskins & Sells
& Ors, Lillian has violated section 180 (1) by failing to maintain a degree of care and
diligence. Moreover, she did not act in good faith by ensuring that her actions did not cause
detriment to the company violation section 181 of the Act (R v Byrnes and Hopwood). She
misused her position to cause detriment to the company due to which she has violated her
duties given under section 182 (1).
Similarly, Gumpta should ensure that a standard is maintained by him while taking business
decisions. He knew that All Mine Pty Ltd would not be able to pay off its debts; however,
Gumpta still formed a contract with the company based on which he violated section 180,
181 and 182 of the Act. Lillian is also liable for violating section 588G (1) of the Act since

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she engaged in insolvent trading practice while knowing that this decision will lead to the
insolvency of the company (R v Byrnes and Hopwood). The directors cannot rely on the
defence under section 588H (4) because both of them were aware regarding these
transactions and they were aware of the same. Moreover, the information given by Gumpta to
Lillian regarding shares of the company was confidential; therefore, they both were involved
in insider trading. They have violated section 1034A of the Act since they misused the
confidential information of the company to gain an unfair advantage (R v Firns). Gumpta has
also violated his duties given under section 183 of the Act since he misused the confidential
information for personal use. The court can impose both civil and criminal penalties on them
to recover loss suffered by both companies.
Conclusion
In conclusion, Lillian has violated her duties under section 180, 181, 182 and 588G of the Act
and Gumpta has violated his duties under section 180, 181 and 183 of the Act. They are also
liable for violating section 1034A since they indulge in insider trading. As potential
consequences, they can be held liable under civil and criminal proceedings.

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References
ASIC v Adler [2002] NSWSC 171
ASIC v Cassimatis (No 8) [2016] FCA 1023
ASIC v Rich (2003) 44 ACSR 341
ASIC v Southcorp Wines (2003) 203 ALR 627
ASIC v Vines (2005) 55 ACSR 617
AWA Ltd v Daniels t/a Deloitte Haskins & Sells & Ors (1992) 10 ACLC 933
Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2
Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115
Corporations Act 2001 (Cth)
Goulding, S 2013, Principles of company law, Routledge, Abingdon.
Howard Smith v Ampol Petroleum Ltd [1974] AC 821
Keay, A 2014, ‘Wrongful trading: problems and proposals’, N. Ir. Legal Q., vol. 65, p.63.
Lee, G & Fargher, N 2013, ‘Companies’ use of whistle-blowing to detect fraud: An
examination of corporate whistle-blowing policies’, Journal of business ethics, vol. 114, no.
2, pp.283-295.
R v Byrnes and Hopwood (1995) 183 CLR 501
R v Firns [2001] NSWCCA 191
Salomon v Salomon & Co Ltd (1897) AC 22