Corporate Law: Director Duties and Legal Consequences

This article discusses the director duties under the Corporations Act and the potential legal consequences for violating these duties. It explores the implications of breaching sections 180, 181, and 588G, including civil and criminal liabilities, insider trading, and possible penalties. Real-life cases and relevant sections of the Act are referenced to provide a comprehensive understanding of the topic.

CORPORATE LAW

ISSUE
The legal issue presented in this case is whether director duties given under the
Corporations Act are violated by Lillian and Gumpta. What are the potential legal
consequences which they might face due to the breach of these duties?
RULE
A corporation is incorporated in Australia under the Corporations Act 2001 (Cth). After its
incorporation, the company gains a separate legal entity which provides it various rights and
liabilities. Due to its separate existence, the liabilities of the members and directors are
limited, and they cannot be held personally obligated for the liabilities of the company.
These characteristics were established by the court in the judgement of Salomon v Salomon
& Co Ltd (1897) AC 22. After this leading case, there were many incidents such as Lee v Lee's
Air Farming Ltd (1960) UKPC 33 case in which the court upheld this judgement by providing
that the directors and shareholders are separate from the company and they are not
personally bound to pay off the debts of the corporation. However, this principle allows
directors, who make business decisions for the company, to take unfair advantage of the
separate existence of the company by hiding their illegal acts. They can easily misuse their
positions and powers to gain personal benefits while adversely affecting the interest of the
company; therefore, various duties are imposed on directors that are included in both
common law and statutes to ensure that they did not misuse their powers and use them for
proper purposes only (Hannigan 2018). Section 180 is a good example which imposes a duty
on directors to ensure that they maintain a standard of care and diligence.
Section 180 (1) provides that the directors should act in a reasonable manner which is
expected for a reasonable person acting in the particular position to ensure that they
discharge their duties for proper purposes only (Hayne 2014, p. 795). Section 180 (2)
provides that this standard is necessary to be maintained by them while they are making
‘business judgements’. The definition of decisions which are referred as ‘business
judgements’ is given under section 180 (3). The court held the director liable in ASIC v
Narain [2008] FCAFC 120 by proving that section 180 (1) by failing to act in a reasonable
manner while making announcement to the public regarding the financial position of the
company. A similar judgement was given in the case of ASIC v Padbury Mining Limited
(2016) FCA 990. Section 181 also imposes duty on director which requires them to act in
good faith of the company. Since a fiduciary relationship exists between directors and the
company, it is their duty that they act in good faith of the company. Section 181 (1) (a)
provided that while exercising their powers and discharging their duties, the directors
should act in good faith to meet the interest of the company. Section 181 (1) (b) provides
that the powers which they have should only be used for a proper purpose only. In the
judgement of Kokotovich Constructions Pty Ltd & Ors v Wallington (1995) 13 ACLC 1113, the
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director was held personally liable by the court because he took the decisions for personal
benefits rather than meeting the best interest of the company and he improperly uses his
position. Thus, the directors have to ensure that they are not causing detriment to the
company while taking business judgements by focusing on their personal interests or acting
in a negligent manner.
Section 183 provides that the information which directors have because of their position
should not be misused and it should be used for proper purpose which did not conflict with
the private interest of directors or cause detriment to the company. Section 183 (1) (a)
requires that the directors should not use the confidential information for gaining personal
benefits in the company. Section 183 (1) (b) provides that they should avoid causing
detriment to the company by using the information which they have while acting as
directors of the company. The court provided in its judgement of ASIC v Sino Australia Oil
and Gas Limited (prov liq apptd) [2016] FCA 42 case that the director is liable for violation
section 183 because the director did not make relevant disclosures and made misleading
claims which caused detriment to the company and leads to its liquidation. Furthermore,
the duty to avoid insolvent trading is also relevant for directors while they are discharging
their duties. This duty is given under section 588G of the Act. As per section 588G (1) (a), a
director, (b) who knew that the company is insolvent or (c) or it is likely to become insolvent
incurred a debt (d) after introduction of this Act can be held liable for insolvent trading.
Section 588G (2) provides that failure to prevent the corporation from incurring debt if it is
insolvent or likely to become insolvent also imposes a penalty on directors (Bhadily & Hosie
2016, p. 247).
As per this section, they should not act negligently. They should maintain a standard of care
and avoid negligently taking business decisions which could lead to the insolvency of the
company. This principle was recognised by the court in Commonwealth Bank of Australia v
Friedrich & Ors (1991) 9 ACLC 946 case. In this case, the court provided that the director is
personally liable for breaching section 588G (2) for incurring debt in the company by giving a
loan which was fraudulent and the directors should have avoided signing annual reports of
the company in which assets were included which the company did not own. The court
provided similar judgements in Elliott v ASIC [2004] 10 VR 369 and ASIC v Plymin (2003) 46
ACSR 126 case by holding the directors liable for negligently or intentionally involving in
insolvent trading. Section 588H provides defences which directors can rely on in order to
avoid their liability which arises under section 588G. As per section 588H (2), if the directors
have a reasonable ground to believe that the company is not insolvent or it is not going to
become insolvent after incurring new debts, then they cannot be held liable under section
588G.
The directors have access to confidential information about the company regarding its
future operations and business decisions; they require this information to discharge their
duties by forming future policies in the company which are focused on meeting the interest
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of the company. It is their duty that they should not use such information which could have
a material impact on the share prices of the company to purchase or sell shares of the
company or they can be held liable for insider trading. The provisions regarding the
imposition of the liability of insider trading are given under section 1013 (1) of the Act in
which this liability is imposed on directors and other officers. Section 1013 (2) prohibits any
other person who use suction information to purchase or sell shares of the company (Denis
& Xu 2013, pp. 91-112). These duties are implemented in the Corporations Act to ensure
that the directors act in a reasonable manner and avoid taking decisions which could harm
the existence of the company or the interest of its shareholders. The directors who violate
these duties can be held liable for civil liabilities. Section 1317E provides civil penalties on
directors if they did not comply with their general duties. The court can impose a fine on
directors and take back their profit which they generated by violating their duties.
Moreover, criminal liability or penalties can be imposed on directors as well. These penalties
are imposed if they act dishonestly towards the company or its shareholders while
discharging their duties.
APPLICATION
In the given scenario, Lillian realised that All Mine Pty Ltd required more computers to
manage its operates; therefore, she made an order at Greedyas Pty Ltd to purchase
computer worth $100,000. She was unaware that the company is close to becoming
insolvent because she did not attend any of the board meetings. Gumpta was the managing
director of Greedyas Pty Ltd, and he heard about the poor financial position of All Mine Pty
Ltd; however, he accepted the order made by Lillian because he wanted to meet his sales
target. Both the directors have violated their duties given under the Corporations Act. Lillian
violated her duties given under section 180 and 181. While taking the business decision, she
did not act in a reasonable manner while focusing on the best interest of the company
which violated section 180 (ASIC v Narain). The provisions discussed in (Kokotovich
Constructions Pty Ltd & Ors v Wallington) case apply in this scenario because Lillian did not
act in good faith while ensuring that the interest of the company is met. Furthermore, she is
also liable for violating her duties given under section 588G of the Act. All the elements of
insolvent trading are present in this scenario. Lillian was acting as a director of the company,
and she incurred debt when the company was about to become insolvent. Lillian is liable for
violation section 588G (2) for her negligence which leads to the insolvency of the company
(Commonwealth Bank of Australia v Friedrich & Ors).
The defences given under section 588H (2) did not apply for Lillian because she did not have
reasonable grounds to believe that the company is solvent as she did not attend any of the
board meetings. In the case of Gumpta, the duties given under section 180 and 181 are
violated. The business judgement taken by Gumpta as a director to accept the order of
Lillian resulted in violating section 180 (2) since it was not in the interest of the company
(ASIC v Padbury Mining Limited). Section 181 (1) (a) is also violated by Gumpta because he
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prioritise his personal interest about the best interest of the company and accepted the
order which leads to causing loss to the company (ASIC v Sino Australia Oil and Gas Limited
(prov liq apptd)). He also violated his duties given under section 183 of the Act. He shared
the confidential information of the company with Lillian, and both of them earn a profit of
$20,000 each by purchasing shares of Greedyas Pty Ltd by involving in insider trading. Since
both the parties were involved in insider trading, they can face the consequences given
under section 1013 (1) of the Act. Based on the violation of duties, both the parties will face
civil penalties by the court. They are likely to be disqualified as directors, and they have to
pay a fine to repay the loss suffered by the company. Gumpta was dishonest towards the
company because he prioritised based on which he can face criminal penalties based on the
discretion of the court.
CONCLUSION
Lillian has violated duties under section 180, 181 and 588G (2); she acted negligently
without inquiring about the financial position of the company. Gumpta violated section 180,
181 and 183 because he misused his position as a director to gain personal benefit while
causing detriment to the corporation. Both directors are likely to be held liable under
section 1013 for engaging in insider trading. The court is likely to take back the profits which
they generated through illegal mediums, and they are likely to suffer civil legal penalty
under section 1317E by paying a fine and disqualification from the position of the director.
Criminal liability can be imposed on Gumpta since he acted dishonestly while taking
business decisions.
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REFERENCES LIST
ASIC v Narain [2008] FCAFC 120
ASIC v Padbury Mining Limited (2016) FCA 990
ASIC v Plymin (2003) 46 ACSR 126
ASIC v Sino Australia Oil and Gas Limited (prov liq apptd) [2016] FCA 42
Bhadily, MA & Hosie, P 2016, ‘Australian employee entitlements in the event of insolvency:
Is an insurance scheme an effective protective measure’, Adel. L. Rev., vol, 37, p.247.
Commonwealth Bank of Australia v Friedrich & Ors (1991) 9 ACLC 946
Corporations Act 2001 (Cth)
Denis, DJ & Xu, J 2013, ‘Insider trading restrictions and top executive compensation’, Journal
of Accounting and Economics, vol. 56, no. 1, pp.91-112.
Elliott v ASIC [2004] 10 VR 369
Hannigan, B 2018, Company law, Oxford University Press, Oxford, UK.
Hayne, KM 2014, ‘Directors' duties and a company's creditors’, Melb. UL Rev., vol. 38, p.795.
Kokotovich Constructions Pty Ltd & Ors v Wallington (1995) 13 ACLC 1113
Lee v Lee's Air Farming Ltd (1960) UKPC 33
Salomon v Salomon & Co Ltd (1897) AC 22
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